When working with our customers, we've noticed that the concern about how to handle inventory is often spoken about at the last minute before things are final. We have also found inventory holding costs are often misunderstood by a wide margin in the paper industry.

A number of cost drivers come into play in holding inventory — and, sometimes even more importantly, in not having enough inventory on hand. Below we put together the facts around this calculation.

Each company is different, but on average your inventory holding cost will be anywhere from 25 to 40 percent of the inventory value on hand. Therefore, if you have $500,000 in inventory, your yearly inventory cost will range from $125,000 to $200,000. Most companies settle in the range of 30-35 percent a year.

With this being said, companies will apply a standard 3 percent "monthly" holding cost. Below is a quick example of how these numbers would break down with an inventory value of $500,000. The yearly cost of inventory comes to $190,000.

Actual inventory costs

Here is the list of costs that go into figuring out your inventory costs.

Cost of capital: 5 percent. The cost of financing money and your companies cost of money.

Destroyed inventory: 3 percent. Inventory that cannot be sold due to damage, poor handling, not packaged securely. Destroyed product is your own people causing the damage.

Damaged inventory: 7 percent. Statistics show the more your inventory is handled, the more it is at risk to be damaged. Moving slow inventory to a different part of your warehouse, not having enough staff or the proper forklift to handle your product all adds to damaged goods.

Obsolete and outdated Inventory: 3 percent. The cost of inventory that is outdated, obsolete, expired. The only option is for scrapping or a discounter.

Theft: 4 percent. Depending on your industry, this may be a major one. In this cost is the money spent on theft prevention as well — closed-circuit security cameras, security guards, software and personnel to monitor and maintain these systems. And, of course, the actual cost of stolen inventory or theft.

Electricity cost: 3 percent. The electricity for heating and cooling needed for this warehouse space

Lost customers: 3 percent. The cost associated with losing a customer due to not having enough inventory on hand. This is one of the hardest to put a number to, and almost no one tracks this number. If you want to see an eye-opener at your next quarterly sales meeting, then show these costs. Well worth the time and effort.

Freight costs: 7 percent. Not having inventory on hand, you will often "rush" or expedite to get products in to make your product. As well as keeping inventory too low, you will expedite orders to customers to meet their deadlines.

Overtime: 3 percent. When you pay your staff overtime to ship and receive product in or out due to not having the correct levels of inventory. This happens when you just get the product in, and you need it shipped and packed the next day for a customer, thus having to pay overtime to have a warehouse person stay late.

Keep in mind these are averages. It is key that you track your own inventory costs, and this is where most companies fall down. Tracking these costs is time-consuming, requires all levels of management buy-in and is often not the most glamorous of work.

Every company should make an attempt at completing these costs. We have heard feedback from customers on how eye-opening the process was and how they had no idea they were spending that amount of money on a particular cost. If you're thinking of taking on a summer project, this is your time to hire that intern and make this one happen.