How to Calculate the Holding Cost of a Spare Parts Inventory: Method and Example
Holding cost is what your inventory costs you every year, on top of its purchase value: tied-up capital, storeroom staff, buildings, scrap and write-downs. Divided by the average inventory value, it gives the holding cost rate, which typically ranges from 15% to 30% per year depending on the industry.
In other words, a €5M inventory can cost more than €1M a year to hold. Yet in many industrial sites, this figure is never calculated. This article gives the formula, details the costs to include and shows why maintenance (MRO) inventories deserve their own calculation.
Holding cost, storage cost, ordering cost: don't mix them up
These three terms are often used interchangeably. They don't measure the same thing, and they don't react the same way when you change your inventory parameters.
Concept | What it measures | It increases when… |
Holding cost | Everything it costs to hold inventory for one year: capital, service, storage, risks | Average inventory increases |
Storage cost | Only one part of holding cost: floor space, racks, handling equipment, property taxes | You need more space |
Ordering cost | What each order costs: issuing, follow-up, receiving, inspection, invoicing | You order more often, in smaller quantities |
Holding cost and ordering cost pull in opposite directions. Ordering rarely in large quantities reduces ordering cost but inflates average inventory, and vice versa. Lot sizing formulas are built to find this balance.
The holding cost and holding cost rate formula
The calculation has two steps. First, add up all the annual costs of holding the inventory. Then divide them by the average inventory value over the year.
Holding cost rate (%) = Annual holding cost (€) ÷ Average inventory value (€) × 100
Once you know the rate, you can use it to estimate the cost of any inventory level, or the gain from a reduction:
Annual holding cost (€) = Holding cost rate × Average inventory value (€)
Savings from an inventory reduction (€) = Holding cost rate × Inventory reduction (€)
For the average value, use at least the average of the opening and closing inventory for the year. An average of the 12 month-end values is more reliable if your inventory moves a lot.
The 4 cost families to include
Holding cost is built jointly by Finance and Supply Chain (or the department that runs the storerooms). All costs are annual.
Family | Costs to look for | Where to find the data |
1. Capital | Cost of financing the inventory and the opportunity cost of non-productive capital, both captured in the weighted average cost of capital (WACC) | Finance department |
2. Service | Storeroom staff and inventory planners, subcontracting, operating costs, dedicated IT (WMS, traceability), inventory insurance, asset-related taxes | Storeroom and purchasing cost centers |
3. Storage | Leases and depreciation of racks and handling equipment, leases and depreciation of buildings, property taxes on floor space | Facilities, management control |
4. Risks | Scrap due to expiry, technical obsolescence or damage, recurring net write-downs | Accounting (provision charges and reversals) |
Capital is calculated directly: inventory value × WACC. With a 10% WACC, every million euros of inventory costs €100k a year before you even count the storeroom.
For recurring net write-downs, take the multi-year average of the gap between provision charges and reversals. Example: €100k of charges and €80k of reversals on average give €20k a year.
What changes with spare parts
A high rate is not necessarily a bad sign. High inventory turnover pushes the cost-to-inventory ratio up, because there are many movements for little inventory. Spare parts are the opposite case, and their costs are distributed differently.
Service weighs less per euro stored. Few movements mean little handling and data entry relative to the value in stock.
Risks weigh much more. When a piece of equipment is replaced or modified, its dedicated parts become unusable overnight, and dormant stock loses value.
Part of the inventory is insurance. Critical parts are kept for a breakdown that may never happen. Their cost runs every year, even if they are never used.
The real issue is therefore how long parts are held. A part kept for 8 years with a 22% annual rate will have generated holding costs equal to 1.76 times its purchase value before it is ever used. This is why the rate must be calculated on your own costs, then applied part by part.
Worked example: a €5M maintenance storeroom
Take an industrial site whose spare parts inventory has an average value of €5M over the year. The amounts below are illustrative.
Family | Detail | Annual cost |
1. Capital | €5M × 10% WACC | €500k |
2. Service | Storeroom staff and planning (€220k), IT (€30k), insurance (€15k), miscellaneous (€25k) | €290k |
3. Storage | Building and rack depreciation (€70k), property taxes (€25k) | €95k |
4. Risks | Obsolescence scrap (€130k), recurring net write-downs (€85k) | €215k |
Total | €1,100k |
The holding cost rate is €1,100k ÷ €5,000k = 22% per year. Keeping an extra €100k of parts for one year therefore costs about €22k.
Common calculation pitfalls
Counting the same cost twice. The storeroom cost center sometimes already includes insurance or rack depreciation. Check each line before adding it to another family.
Forgetting the "risks" family. It is the easiest to overlook and often the heaviest for spare parts. Provisions on dormant stock must be included.
Using a standard rate. A 25% figure found online usually comes from distribution or e-commerce. It reflects neither your WACC, nor your scrap, nor your floor space.
Assuming all costs fall with inventory. Capital and risks fall as soon as inventory goes down. Staff and buildings are partly fixed: they only fall past a certain threshold.
Never updating it. WACC, headcount and floor space change. Recalculate the rate once a year, at year-end closing.
What the rate changes in your inventory decisions
The holding cost rate turns an inventory reduction into euros per year. It supports three decisions.
Building the business case for an optimization project. In our example, reducing inventory by 15% frees up €750k of cash once, then saves about €165k a year (€750k × 22%). Over five years, the cumulative effect far exceeds the cost of a project.
Setting lot sizes. Economic order quantity formulas balance holding cost against ordering cost. With an underestimated rate, they push you to order too much at once.
Choosing the service level. For a non-critical part, every extra unit of safety stock costs its holding rate every year. That cost is weighed against the risk of a stockout, part by part.
Finally, be clear about what you present to management. Lower scrap, write-downs and storeroom costs improve profit directly. Lower cost of capital shows up mainly in cash and working capital.
Frequently asked questions
Who should calculate holding cost? Supply Chain or the storeroom manager, together with Finance. WACC, provisions and depreciation come from Finance; headcount and floor space come from operations.
What is the difference between inventory value and holding cost? Inventory value is what you paid for the parts. Holding cost is what you pay every year to keep them on your shelves.
Does holding cost include stockout cost? No. Stockout cost, meaning the cost of a production stoppage due to a missing part, is calculated separately. It is precisely what you weigh against holding cost.
Calculate your own rate
Our free Excel tool covers the 4 cost families line by line, with guidance for each line. It calculates your annual holding cost, your rate, and the cumulative five-year gain from an inventory reduction.
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