The five components
Storage covers rent, utilities, racking and warehouse handling. Capital cost is the return you give up by putting cash into stock instead of the business. Insurance covers inventory-specific coverage. Shrinkage and obsolescence cover theft, damage, markdowns and dead stock. Other covers admin, systems, taxes and miscellaneous.
Each is expressed as an annual percentage of average inventory value. The percentages should come from your own bills and assumptions, not an industry range.
The formula
Annual carrying cost = average inventory value × (storage + capital + insurance + shrinkage + other). Monthly cost = annual ÷ 12. Cost per unit = annual ÷ average units.
The composition table shows each component's share, which is often more actionable than the total. A 25% carrying rate driven by capital cost calls for a different response than the same 25% driven by shrinkage.
Worked example
Average inventory value $100,000 and 2,000 units. Storage 8%, capital 10%, insurance 2%, shrinkage 4%, other 1% = 25%.
Annual carrying cost is $25,000; monthly is $2,083.33; annual cost per unit is $12.50; monthly cost per unit is $1.04. Capital is 40% of the total, storage 32%, shrinkage 16%, insurance 8% and other 4%.
Why capital cost matters
Warehouse rent is visible; the cost of cash tied up in inventory is not. If the business could use that cash to fund growth, pay down debt or earn a return, the inventory is consuming that return.
There is no universal capital rate. Use a rate that reflects your actual funding cost or opportunity cost, and state it as an assumption. A conservative rate is better than leaving capital out entirely.
How to use it
Compare carrying cost across SKUs or categories, not just in total. A slow-moving SKU with high storage and obsolescence can carry a much higher rate than a fast mover.
Use the unit cost in EOQ and pricing decisions. A $1.04 monthly carrying cost per unit changes the economics of holding an extra two months of stock.
Where the model stops
It excludes step costs such as opening another warehouse, one-off write-downs, and taxes you do not enter. It assumes costs are proportional to inventory value, which is only an approximation.
It also uses one average inventory value. Seasonal businesses should run the model for peak and off-peak periods separately rather than averaging away the peak cost.