Inventory holding cost is the variable cost of keeping items on hand, including interest and handling, taxes, insurance, and shrinkage. When the companies change their inventory levels, holding cost also changes. Typically holding cost of an item ranges from 20 to 40 percent of its value.
Suppose that a company's holding cost is 30 percent. If the average value of total inventory is 20 percent of the sales, the average annual cost to hold inventory is 6 percent - 0.30x0.20 of total sales. This cost is sizable in terms of gross profit margins, which often are less then 10 percent. And it creates a lot of pressure for trimming inventories to increase the gross profit margins.
Suppose that a company's holding cost is 30 percent. If the average value of total inventory is 20 percent of the sales, the average annual cost to hold inventory is 6 percent - 0.30x0.20 of total sales. This cost is sizable in terms of gross profit margins, which often are less then 10 percent. And it creates a lot of pressure for trimming inventories to increase the gross profit margins.
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