Recently, a visitor contacted me by email and asked if I knew how to calculate warehouse carrying costs per square foot. In this case, it's different from calculating storage costs, where the emphasis is on capturing multiple costs and then dividing it by the square footage of the company's warehouse. Instead, this approach is about defining the company's specific costs to hold inventory for long durations, and then using that amount to determine the cost per square foot.
Here is a simple approach to determining warehouse storage costs and a more involved three step approach to defining a company's carrying costs per square foot.
Simple Warehouse Cost Approach
Most approaches have you take your yearly warehouse expenses and divide it by your square footage. So, if your company spent $900,000.00 on warehousing (including all expenses, electricity, employee salaries and benefits, rent, lighting, forklifts, inventory damage, obsolescence, theft, insurance etc.), and had a warehouse with 100,000 square feet in it (500 feet long X 200 feet deep), then your cost per square foot would be $9.00.
However, this doesn't account for your carrying costs per square foot. So, here is a simple three step process to defining your specific costs to carry inventory in your warehouse.
Step1: Determine Your Specific Inventory Costs
Most companies apply a standard 3% monthly inventory carrying cost to the inventory value on hand. Average $1 million held monthly = $30K carrying costs monthly = $360K carrying costs yearly.
However, your company's carrying costs could be higher or lower than 3%. You may not have issues with damage, obsolescence and theft as much as another company. In fact, you might find that your holding costs are closer to 2% - which is not easy to attain.
The excel sheet below allows you to input your individual variables in all blue highlighted areas. You input your average monthly inventory value on hand and then account for financing, damage, obsolescence etc. It is from Sample Inventory Costing Excel Sheet: Graph & Pie-Chart of Expenditures. This will allow you to define your company's specific costs of holding product on your shelves.
You can learn more about carrying costs and lost sales cost of inventory by going to: Inventory Carrying Costs vs. Lost Sales: Both Destroy Your Bottom Line
Step 2: Yearly Carrying Costs Divided by Square Footage
Once you've determined your yearly costs, I would then divide this amount by the square footage in your warehouse. In our table above, it's $350K divided by 100,000 square feet = $3.50 in carrying costs per square foot. Again, define your unique costs and then perform this second step.
Step 3: Focus on Reducing Costs
This is where you effectively lower your carrying costs per square foot by reducing the impact of your specific cost drivers from the second step. Faster sales will reduce these costs as the faster you sell inventory, the less you spend on financing. In addition, damage, obsolescence and theft will be less of a problem. Liquidating slow moving inventory will reduce these costs as well.
In this case, you must increase customer retention, thereby insuring a high rate of inventory turnover. No easy task for sure, but this is a solution that might help: Sample Back-End Rebate Excel Sheet for Customer Retention
The ultimate question is: If you had 1000,000 square feet in your warehouse, then what percentage is used to store high turnover rate products, and what percentage is allocated to slow moving products? In this particular example, 86% of the warehouse was reserved for high sales products, while the remaining 14% was reserved for storage of slower moving product lines - This is extremely impressive as most companies are unable to attain this high a ratio.
This is ultimately why companies should do away with poor performing products. When they don't sell, don't make a mistake by having them occupy too much warehouse space. After this individual performed their evaluation, they emailed me their results.....
"My results look good so I think I am where I need to be. I broke my cost components a little differently but I think the same result wit 23.42% carrying cost with a $123mm inventory cost gives me $29.6mm per year carrying cost."
This was this individual's graph that came from performing the second step of this three step process.
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