Inventory Carrying Cost: What It Is and How to Calculate It

Inventory carrying cost is what it costs you to hold stock over a period, usually a year. It is usually split into four parts: the capital tied up in the stock, the space it occupies, the service costs of holding it (insurance and taxes), and the risk that it is lost, damaged, stolen or becomes obsolete before it sells. It is normally quoted as a percentage of average inventory value per year.

A single blended percentage is easy to use, but it hides the two parts the warehouse controls most directly: how much space each SKU takes up and how much of it disappears.

What is inventory carrying cost?

A widely cited four-part breakdown was set out by Bernard LaLonde and Douglas Lambert in a 1976 paper in the Journal of Food Distribution Research, which listed "four basic costs categories" that "must be considered when calculating inventory carrying costs":

• Capital costs. The money tied up in inventory could be doing something else. The authors argued that "the company's opportunity cost of capital should be used," applied only to the variable costs directly associated with the inventory: for a distributor, what you paid for it; for a manufacturer, variable production cost. Never its selling price.
• Inventory service costs. Insurance bought to cover loss of the stock, and taxes on it.
• Storage space costs. The space the stock occupies, counted only where that cost changes with how much you hold.
• Inventory risk costs. Obsolescence, damage and shrinkage.

A similar split appears at national scale. The Council of Supply Chain Management Professionals' State of Logistics Report, prepared by Kearney, groups US inventory carrying costs into three lines: storage, a financial cost calculated as "WACC x total business inventory," and "Other (obsolescence, shrinkage, insurance, handling, others)." The 2023 edition, the most recent executive summary we could find that publishes the table, put them at $218.5 billion, $313.0 billion and $227.8 billion for 2022, a subtotal of $759.3 billion.

Where does the "25 percent" figure come from?

The idea of one carrying percentage is old. LaLonde and Lambert wrote in 1976 that earlier writers "have estimated that these costs range from 12% to 35%," and that "the traditional industry benchmark of approximately 25% may not be an accurate figure." The paper does not say who first used it.

Their case study shows why it matters. The food company they examined was quoting a carrying cost of "9.5% after taxes or 19.0% before taxes." Rebuilt from the company's own cost of capital, storage, taxes, insurance and losses, the before-tax figure came out at 37.83 percent of inventory valued at full factory cost, almost double the 19 percent the company had been quoting. The point of the paper was not a better constant. It was to calculate your own.

Why one percentage misprices your warehouse

A fixed percentage of value assumes every part of carrying cost grows with what the stock is worth, at a rate that stays put. Neither assumption holds.

Capital grows with value, at a rate that changes. The capital charge is your cost of capital multiplied by the value of the stock, so it moves with interest rates as well as with how much you hold. The State of Logistics figures show the swing: from 2021 to 2022 the financial cost of US inventory rose 90.2 percent, driven by both higher capital costs and larger inventories, while storage rose 18.1 percent. A blended rate set when money was cheap goes stale. For reference, the Federal Reserve's H.15 release showed the bank prime loan rate at 7.00 percent on October 8, 2026. Treat that as a floor, not your number.

Space does not grow with value at all. LaLonde and Lambert noted that "space in public warehouses is usually rented on a dollar per hundredweight or on a volume occupied basis." A pallet of paper towels and a pallet of headphones take up the same standard rack position. Charged as a percentage of value, the paper towels look almost free to hold and the headphones look expensive. (Secure or climate-controlled storage costs more per position, which is another reason to price space directly.)

So a percentage-of-value rate undercharges bulky, low-value SKUs for space and overcharges small, high-value ones. The fix is to split the rate: charge capital as a percentage of value, and charge space per pallet position, bin or cubic foot actually occupied. The position counts live in the warehouse system, not the general ledger, which is why this half of the calculation belongs to operations.

Why carrying cost is hard to see in the accounts

Under IAS 2, the international standard on inventories, the cost of inventories includes purchase, conversion and "other costs incurred in bringing the inventories to their present location and condition." Paragraph 16 lists costs excluded and "recognised as expenses in the period in which they are incurred," including "storage costs, unless those costs are necessary in the production process before a further production stage." Losses of inventory are also expensed in the period they occur. In the US, FASB Statement No. 151 aligned the treatment of abnormal production costs with IAS 2; check the storage treatment for your own reporting with your accountant.

The practical result is that the parts are scattered. Interest sits in finance costs, rent and insurance in operating expenses, shrink and write-downs usually in cost of goods sold, and the opportunity cost of equity tied up in stock appears nowhere. Nobody sees the total unless someone adds it up.

How do you calculate inventory carrying cost?

Work it out per year, using average inventory at cost, and keep every line on the same before-tax basis.

1. Capital cost. Multiply average inventory value at cost by your cost of capital. Use the hurdle rate or weighted average cost of capital your finance team uses, before tax. A borrowing rate usually understates it.

2. Storage space cost. Take the space cost that would change if you held less stock, priced per pallet position, bin or cubic foot, multiplied by the positions each SKU or category occupies. LaLonde and Lambert were explicit that "fixed charges and allocated costs" are "not relevant for inventory policy decisions." A locked-in lease is not a carrying cost unless the space it frees would earn revenue or avoid overflow or expansion costs. Overflow storage rented by the pallet is.

3. Inventory service cost. Add insurance premiums on stock and any taxes levied on inventory. Inventory tax rules vary by state. Texas, for example, has a "Freeport" exemption for goods "detained in Texas for 175 days or less" before being shipped out of state, and a separate goods-in-transit exemption that local taxing units may elect to tax anyway. Check your own state's rules.

4. Inventory risk cost. Add confirmed write-offs for loss, damage, theft and obsolete or expired stock. Do not simply add up count adjustments: they include mis-slots found later and receiving errors, and positive and negative adjustments cancel out. Gross count variance is a data-quality signal; net confirmed loss is the cost. The real cost of inventory inaccuracy post covers how bad counts spread into other costs.

5. Add the four lines and divide by average inventory value for a percentage to compare year to year. Keep the parts: the total tells you how expensive stock is to hold; the parts tell you what to change.

A worked example (hypothetical numbers)

A warehouse rents all its space from a 3PL by the pallet, so every position flexes with stock. It holds an average of $2,000,000 at cost across 1,000 pallet positions.

• Capital: 9 percent before-tax cost of capital × $2,000,000 = $180,000
• Space: $15 per pallet position per month × 1,000 × 12 = $180,000
• Service: insurance and inventory taxes = $30,000
• Risk: confirmed loss, damage and write-offs = $70,000

Total: $460,000, or 23 percent of average inventory value. Now take two SKUs that each hold $20,000 of stock. One fills 40 pallet positions; the other sits on one pallet. At a blended 23 percent, both cost $4,600 a year to hold. Split, the bulky SKU costs $1,800 in capital, $7,200 in space and about $1,000 in service and risk at the warehouse average, roughly $10,000 a year, half its own value. The compact SKU costs $1,800, $180 and about $1,000, roughly $3,000. The blended rate was hiding a three-to-one difference. Use your own rates, space costs and loss history.

What can the warehouse do with the number?

• Find SKUs that occupy space out of proportion to their value. Compare positions or cubic feet per SKU with inventory value. The ones high on space and low on value are where holding less frees the most room.
• Make the risk line honest. Counting high-value and fast-moving items more often, as in ABC inventory classification, may push recorded losses up at first, because hidden losses get found. That is the first step to reducing them.
• Revisit order quantities when rates move. A higher carrying rate argues for smaller, more frequent orders and more scrutiny of buffers on low-margin SKUs. The safety stock formula itself has no cost input, but the service level you target can.

Common mistakes

• Applying the capital charge to retail price. The money tied up is what the stock cost you.
• Mixing before-tax and after-tax rates, the trap in LaLonde and Lambert's own case study.
• Loading the whole building into storage cost, which makes every SKU look more expensive to hold than it is.
• Using one rate for every SKU. Fine for a board slide; not for deciding what to hold less of.

The short version

Carrying cost is capital plus space plus service plus risk. The familiar single percentage is an old benchmark that researchers warned in 1976 may not be accurate. Calculate capital on what the stock cost at your own before-tax cost of capital, space on the positions stock actually occupies, and risk from confirmed losses. Keep the parts separate: the warehouse can act on the space and risk lines in a way it never can on a blended percentage.