Inventory Costs: Calculation and Reduction Guide (2026)

Inventory costs shape margins and business decisions. Learn total cost calculation methods and practical ways to cut excess expenses.

Inventory is a retail business’s largest expense. For every dollar US retailers make, they have $1.26 of inventory in stock, according to the Federal Reserve Bank of St. Louis. 

Inventory costs extend beyond the purchase price. Understanding them requires factoring in all the expenses related to ordering, storing, and managing stock.

This guide covers what inventory costs are and how to calculate them, for a clearer view of your expenses. You’ll also learn the different types of costs that come with managing inventory, how to reduce inventory costs, and common mistakes to avoid.

What are inventory costs?

Inventory costs include the money retailers spend to buy, order, store, manage, and hold stock. They also include inventory-related risks like product obsolescence. 

Knowing an inventory’s value and related costs helps retailers make pricing and purchasing decisions. The main inventory cost categories include:

• Ordering costs. The expenses of placing and processing supplier orders.
• Holding or carrying costs. The expenses of warehouse rent, insurance, and storing unsold stock.
• Shortage costs. The financial loss from running out of stock, including lost sales and emergency shipping fees.
• Capital costs. The money tied up in inventory that you could invest elsewhere.

Put together, these costs affect profit margins and the amount of cash retailers need to buy inventory.

The importance of inventory costs

Inventory costs include more than the price you pay for products. They can affect cash flow, profit margins, and day-to-day operations.

According to Shopify’s November 2025 Merchant Survey, store owners who review finances infrequently (less than monthly) report higher rates of inventory and cash flow challenges, while those with regular financial reviews are more likely to hit revenue milestones and achieve profitability. Sixty-nine percent of surveyed store owners review finances at least weekly.*

A clear view of inventory-related costs helps retailers spot inefficiencies. For example, if holding costs are cutting into margins, retailers can review replenishment timing, negotiate storage terms, or adjust pricing for slow-moving items.

Types of inventory costs

Inventory cost terminology varies by source, but most fall into the following categories. Track these costs to see how inventory decisions affect expenses beyond the product’s purchase price:

• Purchase costs
• Ordering and reordering costs
• Storage costs
• Inventory carrying costs
• Capital costs
• Shortage costs and lost sales
• Interest costs
• Lost or stolen inventory
• Customer service costs
• Obsolete spoilage costs

Purchase costs

Purchase cost is the price a supplier charges you to buy their products. If you buy 100 pairs of sneakers from a footwear wholesaler at $12 per pair, your purchase cost is $1,200. This figure excludes processing, shipping, and handling fees.

Ordering and reordering costs

The process of ordering inventory from a supplier involves multiple expenses:

• Purchasing department costs. If you hire a buyer or an assistant to purchase products, their salaries, benefits, and taxes are part of your ordering costs.
• Transportation costs. Shipping items from a supplier to your store involves charges like freight fees, courier fees, import duties, and insurance. These expenses factor into your total ordering costs.
• Receiving and inspecting costs. When you receive inventory, staff members check the delivered items against the purchase order, examine the quality, and arrange returns. These labor costs are part of your ordering costs.

Ordering costs vary depending on the retailer, but they include the expenses involved at every step of the procurement process, from placing an order with a supplier to receiving the items in your store. Use this formula to calculate your total ordering costs:

Total ordering costs = Purchase department costs + [Number of orders per month x (Transportation costs + Receiving and inspecting costs)]

Storage costs 

Storage costs include warehouse rent as well as utilities, maintenance, security, insurance, and labor for managing the space.

A furniture store might rent a warehouse for $5,000 per month. That rental fee is part of the store’s costs, but it doesn’t cover every storage expense. If the retailer operates multiple warehouses, differences in local utility rates or security needs can increase expenses.

Underused warehouse space still requires heating, cooling, and upkeep. A unified inventory system such as Shopify can keep inventory data in one place and show stock levels across warehouse locations.

Inventory carrying costs

Holding or carrying costs are interchangeable terms that include more than storage expenses. Storage costs are one part of carrying costs, but carrying costs are the total financial burden of holding inventory over time.

These figures help retailers decide how much beginning inventory to buy and how much stock to keep on hand. They can include warehouse or storage rental costs, interest on money tied up in inventory, insurance, taxes, depreciation, and the risk that inventory becomes obsolete, damaged, or sold at a loss.

For example, if a business holds $100,000 in average inventory and estimates a 20% annual carrying cost rate, that inventory costs $20,000 per year to hold.

Capital costs

Capital costs are the funds a store owner gives up when money stays tied to inventory. If a store has $80,000 sitting in stock, that $80,000 can’t earn interest, pay down debt, fund ads, or go toward the next product run.

Use this formula to estimate annual capital cost:

Annual capital cost = Average inventory value x expected annual return

Say a store carries $80,000 in average inventory value and estimates that money could earn an 8% return somewhere else. The annual capital cost is $6,400.

$80,000 x 8% = $6,400

The $6,400 figure estimates the return the store gives up while that cash stays in inventory.

Shortage costs and lost sales

Retailers incur expenses when inventory isn’t in stock. Inventory shortage costs are the expenses to manage stockouts, such as customer service payroll and reorder fees.

Say an electronics store experiences a smartphone stockout that causes 10 lost sales. Each smartphone yields a $100 profit, resulting in $1,000 of missed profit. The stockout requires $400 for customer service and $400 for reordering.

Calculate total shortage costs with this formula:

Total shortage costs = Customer service costs + Reordering costs + Lost sales

The calculation for this example is:

Total shortage costs = $400 (Customer service) + $400 (Reordering) + $1,000 (Lost sales) = $1,800 

Interest costs

Interest costs are the financing charges a business pays to borrow money. They are different from capital costs which is money tied up in inventory. If the annual interest on your inventory loan is $2,400, or $200 per month, that amount is part of your overall holding costs.

Lost or stolen inventory

Shrinkage is the difference between recorded inventory and the stock a retailer can physically account for. It can come from shoplifting, employee theft, administrative errors, damaged goods, vendor issues, or mistakes during location transfers. In its 2026 Total Retail Loss Benchmark Report, Appriss Retail estimated that retailers faced $89 billion in shrink-related losses in 2025.

Customer service costs

When a store experiences a stockout during a product launch, the customer service team answers inquiries, manages complaints, and updates customers on availability.

Two customer service employees each work an extra 10 hours a week on stockout issues. At $20 per hour, the additional customer service costs equal $400 per week.

Obsolete spoilage costs 

Inventory can get damaged or become obsolete over time. For example, a chair could get scratched during handling, or a table style could go out of fashion, requiring you to sell it at a retail markdown.

If you lose an average of $1,000 per month to damaged goods and $1,000 per month to discounts on obsolete items, those amounts count toward holding costs.

Add these costs to calculate total holding costs:

Total holding costs = Storage costs + Monthly interest costs + Damage + Obsolescence

Using this example:

Total holding costs = $5,000 (Storage) + $200 (Interest) + $1,000 (Damage) + $1,000 (Obsolescence) = $7,200 per month

How to calculate inventory costs 

The formula for calculating inventory costs is:

Inventory costs = Purchase costs + Ordering costs + Holding costs + Shortage costs

Here’s an example using a sneaker store that needs to reorder inventory after a stockout during an anniversary sale:

• Purchase costs. The store needs 100 pairs of sneakers. The supplier charges $12 per pair, which makes purchase costs $1,200.
• Ordering costs. The supplier is in China and charges $100 for express shipping to North America to fill back orders. The store also needs to rent a truck to transport the shipment from the store to the warehouse. Truck rental for three hours costs $60. Together, ordering costs are $160.
• Holding costs. The store pays $800 each month for warehouse space. This sneaker order represents one-tenth of total inventory. With 30 inventory days on hand, holding costs are $80.
• Shortage costs. This shipment is a reorder because the store sold out of these sneakers during the sale, so it has shortage costs. The main expense was payroll for customer service and marketing teams, who fielded customer questions about the stockout. That cost $400.

When purchase costs ($1,200), ordering costs ($160), holding costs ($80), and shortage costs ($400) are added together, the total inventory cost for this shipment of sneakers is $1,840.

How to reduce inventory costs in retail

According to the November 2025 Shopify Merchant Survey, ensuring stable cash flow is store owners’ top business goal overall, at 34%. When a business has $1 million or more in revenue, the top goal becomes reducing operating costs, signaling that reducing inventory costs becomes a strategic priority as businesses grow. 

Follow these tips to keep inventory costs low:

Unify your data

A unified commerce system can save retailers money. When you rely on shared inventory data for demand forecasting, you’ll be able to avoid costly inventory challenges like overstocking and stockouts.

Unified commerce works when ecommerce and point-of-sale (POS) systems use the same platform. Shopify’s commerce solutions are built on a single platform and share a common data model. Store owners use shared data to decide what to stock, where to stock it, and when to reorder.

An EY report found that a unified commerce approach:

• Increases overall sales by 8.9% on average
• Cuts total cost of ownership by 22% compared to other systems
• Lowers staff training and onboarding costs by 21% per retail location

South African sneaker brand Bathu, for example, experienced a 26% increase in revenue after unifying its data with Shopify. “We realized that at the rate we were opening stores, it would be a lot cheaper for us to run Shopify POS—and on top of that, everything would be centralized,” says Mario Toscano, technology and innovation manager of Bathu.

Find the right balance

Ordering larger volumes of inventory reduces purchasing costs through volume and shipping discounts. However, larger orders increase storage fees. Economic order quantity (EOQ) is the order size that minimizes both storage and ordering costs.

The just-in-time (JIT) approach means you receive inventory directly before selling it, rather than keeping it on hand for weeks or months. This inventory management system reduces storage needs and keeps stock moving.

Optimize inventory storage costs

Lower inventory costs through storage optimization. With Shopify, store owners can control where inventory is stored, how it moves between locations, and how quickly it sells.

Using Shopify’s built-in inventory management, you can track stock across locations in real time, organize products with bin locations, create and receive transfers between locations, and use inventory reports to monitor stock levels, sell-through, and replenishment needs.

While Shopify does not calculate storage overhead directly, it provides the data to make strategic storage decisions.

Automate inventory replenishment

Automated inventory replenishment takes the manual processes out of reordering. Calculate reorder points for inventory and set up recurring orders so you don’t risk going out of stock.

Shopify helps by tracking inventory in real time, managing purchase orders, and sending automated low-stock alerts through Shopify Flow. It supports replenishment decisions, but fully automatic recurring reordering still requires manual steps or a Shopify app like Low Inventory Alert Guru.

Increase inventory turnover rates

Calculating inventory turnover rate shows how quickly a business sells inventory. The longer inventory sits in stock, the more merchants spend on storage costs. You can increase your turnover rate with an ABC analysis, which categorizes products based on their inventory value and sales performance. This allows you to prioritize the items that impact cash flow and storage needs the most.

For example, imagine a bike store. After calculating the inventory turnover rate for all of the bikes they sell and using ABC analysis, the owner finds that children’s bikes don’t sell as quickly as adult bikes. The owner decides to pause orders on new children’s bikes and create family bike bundles to sell down existing stock.

Get rid of dead stock

When inventory turnover rate calculations and ABC analysis reveal products that aren’t selling, a business has dead stock. Store owners clear this stock by discounting items or donating them in kind for a tax write-off. 

You can deduct up to half the difference between the selling price and cost of goods sold (COGS), as long as it doesn’t exceed twice the COGS.

Let’s say you purchase a piece of inventory for $10 and sell it for $30. The difference between the COGS ($10) and selling price ($30) is $20. Because half of $20 is $10, which doesn’t exceed it twofold, you can deduct $20 for the item for tax purposes.

Common inventory costing challenges 

Inventory costing can be challenging, but modern POS and ecommerce technology can help you manage it more easily. 

Siloed inventory data

Disconnected and inefficient inventory management systems can lead to numerous errors and increased costs. 

Unified commerce centralizes sales channels, operations, back-end workflows, and customer-facing shopping experiences. Having ecommerce and POS solutions on the same platform allows store owners to increase efficiencies and reduce costs while also creating a better customer experience. 

Take urban mobility brand WeeBot, for example. In their early days, they kept track of orders, stock, and payments via an Excel spreadsheet. After switching to Shopify, they saw a 15% increase in revenue, 50% reduction in in-store processing time, and a 50% better customer satisfaction rate.

Inaccurate stock counts 

Any discrepancies between actual and recorded inventory can lead to miscalculations in inventory costs. Regular physical counts and reconciliations with recorded inventory can help avoid this mistake.

Shopify’s barcode scanners let store staff take accurate stock counts efficiently. Everything is tightly integrated from a unified system, so you can sync current and historical data between retail and other channels like online or wholesale. 

Lack of inventory management software 

Some retailers operate without advanced inventory management software. Inaccurate data, missed sales opportunities, and poor forecasting are all potential outcomes of a manual system. Modern, comprehensive inventory management technology like Stocky allows for more cost-effective inventory handling.

Stocky has tools to create and manage purchase orders, communicate with suppliers, conduct stocktakes, use in-depth reporting, and review and receive incoming inventory with barcode scanning and in Shopify POS.

*Based on a 2025 survey of 500 Shopify merchants conducted in English across Australia, Canada, the United Kingdom, Ireland, New Zealand, and the United States. Respondents were established merchants with two or more years on the platform. Results reflect the experiences of this specific sample and may not be representative of all merchants.

Inventory costs FAQ

What are the different types of inventory costs?

The main types of inventory costs include:

1. Acquisition costs. The costs associated with purchasing and receiving inventory items.
2. Holding costs. The costs associated with storing and maintaining inventory items.
3. Ordering costs. The costs associated with ordering and preparing inventory items for sale.
4. Stockout costs. The costs associated with not having the inventory items available when customers want them.

What are inventory fees?

Inventory fees are the additional charges or expenses incurred beyond the product’s purchase price when managing inventory. These fees can include storage or warehousing fees, handling fees, processing fees, and administrative fees.

What is inventory costing with an example?

Inventory costing is the process of calculating all costs associated with acquiring, storing, and managing your products. For example, consider a retailer who orders 100 pairs of sneakers at a unit purchase cost of $50. Ordering and shipping costs $150, and storage and insurance cost $1,500. The total inventory cost would be: Total Inventory Cost = $5,000 (Purchase) + $150 (Ordering) + $1,500 (Holding) = $6,650

How much are inventory costs?

Inventory costs vary by industry, product type, and operational efficiency. A 2026 retail inventory benchmark found that most retailers spend 20% to 30% of their average inventory value each year on carrying costs, with categories like fashion and home goods often landing higher because of obsolescence, markdowns, and storage needs.

What is the difference between inventory holding costs and storage costs?

Inventory holding costs include all expenses tied to keeping unsold inventory, such as insurance, depreciation, shrinkage, and capital tied up in stock. Storage costs are one part of holding costs and refer to the expense of physically storing products, such as warehouse rent, utilities, and handling.