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In business management, holding cost is money spent to keep and maintain a stock of goods in storage.
The most obvious holding costs include rent for the required space; equipment, materials, and labor to operate the space; insurance; security; interest on money invested in the inventory and space, and other direct expenses. Some stored goods become obsolete before they are sold, reducing their contribution to revenue while having no effect on their holding cost. Some goods are damaged by handling, weather, or other mechanisms. Some goods are lost through mishandling, poor record keeping, or theft, a category euphemistically called shrinkage.
Holding cost also includes the opportunity cost of reduced responsiveness to customers' changing requirements, slowed introduction of improved items, and the inventory's value and direct expenses, since that money could be used for other purposes.
While it is possible to measure the components of holding cost, it is common to estimate them as at least one-third the value of the stored goods per year. If opportunity cost is included, it is reasonable to use one-half the value of stored goods as their holding cost.
The effect of reducing the value of inventory by $1,000,000 reveals the effect holding cost has on its owner. If holding cost is set at one-third of the inventory's value, $333,333 becomes available for other purposes. At the higher rate, $500,000 becomes available. Whether that money is added to net income and profitability or used for other purposes, it is a noticeable amount.
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