What are the primary reasons for holding inventory?

Learn the reasons for holding inventory and its effects.

view of a warehouse shelving aisle

Picture this:

You’re a manufacturer who produces high-end furniture for your clients. You source raw materials from suppliers with three to four weeks lead time, and your entire production process takes another two. 

To ensure you can meet customer demand quickly and efficiently—and to keep customers happy—you keep raw materials and the finished products on hand. 

This ability to meet customer demand without delays is but one reason for holding inventory. 

Five additional reasons for holding inventory

Holding inventory offers a host of other benefits—from helping you reach your profit targets and avoiding costly stockouts to reducing costs and protecting against unforeseen supply chain disruptions that can really throw a wrench into your operations.

  1. Reach your profit targets. Meeting customer demand promptly means you’re better poised to reach your revenue and profit targets.
  2. Reduce customer lead times. You can fulfill orders immediately without having to order from suppliers and wait for delivery. Faster order fulfillment keeps customers satisfied and loyal.
  3. Avoid stockouts. Stockouts occur when you run out of a particular product, which can be costly, leading to lost sales and customers. This is a distinct possibility during busier periods, and it’s why, for example, retailers hold extra inventory during the festive season. 
  4. Reduce costs. You avoid having to place last-minute orders, which usually cost more, and you can take advantage of quantity discounts and reduced shipping costs by ordering in bulk.
  5. Avoid supply chain disruptions. Unforeseen disruptions in the supply chain can lead to order delays, unhappy customers, and lost profits. Maybe a manufacturer had to shut down their operation for a few days due to health and safety concerns. 

Perhaps the lead time on a particular component is longer than usual due to labor strikes in a factory. Regardless, by having safety stock on hand, you protect against these scenarios—avoiding delays in shipping and production—and can continue to meet customer demand. 

A word of caution on holding inventory

As important as holding inventory may be, carrying too much can be detrimental. With too much capital tied up in stock that you could use elsewhere, your carrying or holding costs will soar, where:

Carrying cost refers to all the costs of storing and maintaining inventory, including warehousing, wages, transportation, insurance, security, depreciation, rent, utilities, and taxes. 

You can calculate it using the inventory holding cost formula:

Total Holding Costs / Total Annual Inventory Value* 100

For example, if you hold $200,000 worth of inventory and your total holding costs are $15,000, then your holding cost percentage is 20%.

By analyzing your carrying costs, you can make better inventory management decisions to boost your bottom line, including determining the optimal amount of inventory to hold and pinpointing strategies to control holding costs. 

One way to keep carrying costs in check is to calculate the correct reorder point: the inventory level at which you should replenish stock.

Learn more by reading our short guide on the reorder point and how to calculate it.