The Concept of Carrying Cost for Your Finances

by Kevin on August 30, 2013

In business there is a concept called carrying cost. That is, what is the cost of carrying inventory from the time it is produced to the time it is sold.

Let’s say you make laundry detergent. It gets produced, bottled up, and shipped out to a warehouse. It sits on a shelf waiting for another order from Target or Wal-Mart before it is shipped out to the customer.

All of the costs associated with shipping the bottle to the warehouse and then to the customer plus the cost of the warehouse (including utilities) plus the cost of the salaries of the employees performing all of those tasks gets wrapped up in to carrying cost.

Even things like opportunity cost come in to play where the money spent on carrying cost could have been spent elsewhere, like research and development on a thinner bottle that would be just as strong but use less plastic and thus cost fewer dollars.

Carrying cost is why production systems like Just In Time (JIT) have taken off. If I manufacture cars the carrying cost of them sitting in a lot waiting to be shipped out to a dealership is significant. So I produce them just as I need them so I don’t have hundreds of cars sitting around costing me money.

Can we apply this concept to our finances? You betcha.

Carrying Cost for Individuals and Families

Okay, so we’re not a big manufacturer cranking out any products, but carrying cost does apply to our day to day lives as well.

Interest and Taxes

For anyone who buys a home with a mortgage one of the largest carrying costs is your mortgage interest and property taxes. On a 30 year note you can almost buy a house twice: once for the principal amount and again for the interest you pay over those 30 years.

Property taxes in some states are astronomical. They apply every single year as long as you own the property.

Spoilage

Have you ever purchased something in bulk because you thought it was a good deal only to discover it in the back of your pantry next spring when you clean out? Or cooked up a wonderful meal with the intentions of eating leftovers, but never getting around to it? You’ve literally just thrown money away.

Gas Mileage and Insurance

You have two options: the older, not flashy car with better gas mileage or the brand new vehicle with all the power under the hood you could want. I’m a car guy so I can see the attraction to the latter of the two.

But in choosing the latter you end up with a payment (more interest cost), lower gas mileage (so your monthly gas costs are higher) and higher auto insurance costs (that will take years to come down)…all from one decision.

Opportunity Cost

The biggest cost in most of our lives, if we could see it right in front of us, is that of opportunity cost.

We buy the big house with the big payment and the huge interest payments, and we miss out on an investment opportunity or having the cash to start our own business on the side.

We hand over thousands of dollars in taxes to live in the big house when we could use those dollars on a once in a lifetime trip.

We buy the nicer vehicle but can’t afford to spend as much time with our kids because we’re busy earning dollars to make the payment and keep the tank full.

What’s Your Carrying Cost?

Take a look around your home. What’s costing you money to carry right now?

{ 1 comment }

S. B. September 10, 2013 at 10:25 pm

This article brings up some very good points. The carrying costs of a house are the property taxes, the fire/hazard insurance, and basic maintenance costs. This is what it costs you to simply “carry” the house. Strictly speaking, I wouldn’t classify mortgage interest as a carrying cost, as that is a financing decision. It’s possible to avoid mortgage interest, but not taxes and insurance.

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