What stock costs

Holding stock costs money even when nothing happens to it. The holding (or carrying) cost includes the cash tied up (which could have paid off a loan or earned interest), warehouse space, insurance, handling, and the risk that goods are damaged, stolen or go out of date. Added up it's often 20% to 30% of the stock's value a year. Hold $400,000 of stock at 25% and it costs about $100,000 a year just to keep it.

Ordering also costs money: someone has to raise the order, the goods have to be delivered and checked, and the invoice paid. That ordering cost is roughly the same whether the order is big or small, so ordering less often but in bigger amounts saves on ordering costs but raises holding costs. The next lesson shows how to balance them.

Then there's the cost of running out, a stockout: the lost sale, perhaps the lost customer, rush freight, or a production line standing still. It's harder to put a number on, but it's often the biggest of the three.

Inventory turns measure how quickly stock sells. Divide the cost of goods sold in a year by the average value of stock held. A company that sold $1,200,000 of goods (at cost) and held $200,000 of stock on average turned its stock 6 times. A supermarket might turn fresh food 50 times a year; a jeweller maybe twice.

Days of supply says how long the stock on hand will last at the current rate of use. 600 units, selling 40 a day, is 15 days of supply. You can also get it from turns: 365 ÷ 6 turns ≈ 61 days of stock on average.