what are holding costs 
holding costs are those associated with storing inventory that remains unsold these costs are one component of total inventory costs along with ordering and shortage costs a firm s holding costs include the price of goods damaged or spoiled as well as that of storage space labor and insurance understanding holding costsminimizing inventory costs is an important supply chain management strategy inventory is an asset account that requires a large amount of cash outlay and decisions about inventory spending can reduce the amount of cash available for other purposes for example increasing the inventory balance by 10 000 means that less cash is available to operate the business each month this situation is considered an opportunity cost holding costs exampleassume that abc manufacturing produces furniture that is stored in a warehouse and then shipped to retailers abc must either lease or purchase warehouse space and pay for utilities insurance and security for the location the company must also pay staff to move inventory into the warehouse and then load the sold merchandise onto trucks for shipping the firm incurs some risk that the furniture may be damaged as it is moved into and out of the warehouse holding cost reduction methodsone way to ensure a company has sufficient cash to run its operations is to sell inventory and collect payments quickly the sooner cash is collected from customers and the less total cash the firm must come up with to continue operations businesses measure the frequency of cash collections using the inventory turnover ratio which is calculated as the cost of goods sold cogs divided by average inventory for example a company with 1 million in cost of goods sold and an inventory balance of 200 000 has a turnover ratio of five the goal is to increase sales and reduce the required amount of inventory so that the turnover ratio increases another important strategy to minimize holding costs and other inventory spending is to calculate a reorder point or the level of inventory that alerts the company to order more inventory from a supplier an accurate reorder point allows the firm to fill customer orders without overspending on storing inventory companies that use a reorder point avoid shortage costs which is the risk of losing a customer order due to low inventory levels the reorder point considers how long it takes to receive an order from a supplier as well as the weekly or monthly level of product sales a reorder point also helps the business compute the economic order quantity eoq or the ideal amount of inventory that should be ordered from a supplier eoq can be calculated using inventory software 