How to calculate Inventory Cost?


Below image gives an idea on the components that are required to arrive at the Finished Goods costing and also how to calculate the Inventory costing.  Here we are making an attempt to explain the inventory cost and how its calculated etc?

How to Calculate Inventory Carrying Cost


Recently we spoke few Customers, who are worried about the increasing costs of doing the business. One of the factor was inventory cost and they were struggling to find the cost in a more proper and scientific way. So we asked few questions to find how the inventory costing is done by them?

  1. What’s your cost of Finished Goods? How you arrive?
  2. How much Raw Materials costs have increased in last one year?
  3. Whats the cost of labour or Machine costs that incur?
  4. How much is the Electricity and other expenses?

Many business owners have a fair idea of their Inventory Carrying cost of the raw materials and how much them goes into Finished Goods. But do they address the real costs?

No. Because customer Accounting software doesn’t allow. So how the inventory costing is done? What are the parameters to be considered?

So many business owners depend on Excel document with many parameters and these are identified at the time, when the Finished Goods (FG) Costing was arrived and when the Quote was given at the beginning. But as the time passes, the Raw materials (RM) cost goes up and these are not added back to FG Costing to arrive at the real cost and increase the FG selling cost.   Many follow this below shown costing approach.  We took an example of an Automobile Component manufacture that manufacturers and sell U-Bolts. The figures are fictional and not an actual  

NoMajor ComponentsDetailsCost (Rs.)
1Raw MaterialsEN-8 materials of 100mm length and Dia16 mm
Packaging Material costs3.5
2Operation costCutting
3Total cost of Finished Good118.50
4Overhead costs30% of total cost35.55
5Profit Margin30% of the total Cost including Overhead cost46.25
6Total Selling price200.30

In this rough costing there are many things are missing

  1. Cost of raw materials – Typically RM price changes based on the demand and Supply. So the cost could go up or down. So the right model is to have a Weighted Moving Average Cost (WMAC) as it takes into the account the Past costs and also the Current purchase prices. uses this model.
  2. Activity based costing – (ABC) – Each activities costs would increase depends on the labours who work on the machines. You can not take an Average cost as the employee costs changes every year and its advisable to take the actual labour costs that are used for those machining activities. This ensures that all the costs are factored.
  3. Subcontracting costs – If we are sending the materials to an outside agency that does hardening or blackening operations and these costs should to be added to your RM costs. Many customers don’t know how to do this?
  4. Other costs
    1. Furnace oil used for the operation
    2. Electricity consumed
    3. Other overheads
  5. Biggest problem is how these are added to the RM costing at the time of Conversion to FG?

Many SME Business Owners don’t follow this because their Accounting Software is old and doesn’t allow these dynamic changes.

Let’s check how would do this?

NoMajor ComponentsDetailsCost (Rs.)Whats the problem?How helps?
1Raw MaterialsEN-8 materials of 100mm length and Dia16 mm
100Purchase price may change for Every Goods receiptAt the time of Purchase, we average the costs by WMAC method
Packaging Material costs3.5Purchase price may change for Every Goods receiptAt the time of Purchase, we average the costs by WMAC method
2Operation costCutting
2.00Once in 6 to 12 monthsLabour, Machine costs
Bending2.00Once in 6 to 12 monthsLabour, Machine costs
5.00Once in 6 to 12 monthsLabour, Machine costs
Hardening4.00Once in 6 to 12 monthsLabour, Machine costs
Blackening1.00Once in 6 to 12 monthsLabour, Machine costs
Packaging1.00Once in 6 to 12 monthsLabour, Machine costs
Total cost of Finished Good118.50
Overhead costs30% of total cost35.55Changes once in a yearBill of Materials (BOM) Overhead costs
Profit Margin30% of the total Cost including Overhead cost46.25Depending on Business OwnersSales Decision and upload the Price Lists
Total Selling price200.30
Many customers could able to find the value as’s costing approach and arrive at the cost is almost fool-proof. There could be some extreme cases we may not able to work. But 99% we are accurate and better than your accounting software.

Fix your product demo at your convenience.


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  1. Check here the’s ERP Features

  2. How to implement an ERP Software that’s easy and quick to do?

  3. Problems that are faced by an ERP implementation

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Nityananda Rao, (BE, PGDGM and INSEAD Alumnus), is the CEO of AcTouch Technologies with 20+ years of experience in ERP, Banking and Treasury Solutions. He is a Mechanical engineer who worked on shop-floor with CNC Machines, SP-300 like Injection Moulding machines. He is a authority on ERP and it's features. Prior to starting AcTouch Tech, he worked with Infosys, Misys, Murex etc managing APAC region as profit centre.