Inventory can be a funny thing. It’s the backbone of any retail business, whether business-to-business or customer-facing, and yet it can be one of the biggest drains on profit and income.

Even with all of the problems that can arise from items being out-of-stock, maintaining items can bring with it a unique series of expenses and challenges that can really start to affect your bottom line if not attended to. Identifying and understanding the four most common and resource-draining inventory costs can be crucial to reducing overhead and preventing a major loss in finances:

Capital costs:

The largest factor of calculating inventory costs, capital costs include everything related to the investment and finances of your warehouse or distribution center such as the initial investment, any available working capital your facility has, and the opportunity cost of the money you’ve invested in your inventory.

These costs tend to be deeply underestimated by inventory buyers, and this can lead to huge capital shortages down the road if left unchecked. However, they can be easily prevented by using a formula known as a weighted average cost of capital to determine the rate a company is expected to pay on average to finance assets.

Storage space costs:

Above and beyond installations like steel shelving and pallet racks, storage space costs constitute everything you’re paying for to keep your items stored. From the actual shelves and racks in the warehouse to site rent on the warehouse itself, utility costs, and even the handling costs of moving inventory in and out of the warehouse such as paying for your supply chain. These costs are some of the most unavoidable in warehousing, but can also mount up the most quickly if not monitored correctly.

Inventory services costs:

While storage space costs constitute the financial burden of having to store and retain products, inventory service costs are any cost that arises from maintaining and distributing items. These costs can include insurance, IT hardware, tax payments, and expenses related to labor such as physical handling, inventory control, and cycle counting. The higher the level of inventory in the warehouse, the higher these costs are sure to become.

Inventory risk costs:

Long-term stocking of any inventory item carries a lot of risk with it, such as the item no longer being sellable, demand suddenly dropping, or the item becoming completely obsolete. Even speaking for internal warehouse issues, risks can further include shrinkage (the loss of products between recorded inventory and actual on-hand inventory), administrative errors, theft, damage, and more. Storing any item can bring the risk of the item becoming more costly than it’s worth, and these risks have to be carefully monitored and managed.

By better understanding these costs you can help to mitigate any inherent risk and keep your warehouse operating profitably and with more stability.