Any business that ships or stores products and materials must monitor its landed cost and carrying cost. Understanding your inventory levels and shipping expenses is essential to lowering expenditures and will help boost your profit margins.
In this article, you’ll learn about the importance of tracking landed costs, the formulas you need to calculate your profits and expenses, and tips for cost-effective inventory management and distribution.
A landed cost is the total amount of money it costs to fill an order for a customer.
Also called the total landed cost or landed price, it’s an important term for e-commerce, manufacturing, and distribution companies that ship physical products. Landed costs include expenses like:
Whether you’re sending shipments across state lines or across the globe, knowing the true cost of the products you ship is essential to making informed business decisions. While the actual shipping costs are important, they're just one part of a much larger equation that impacts your team, your customers, and your bottom line.
Freight on board (FOB) is the price a retailer pays their supplier to acquire goods for them. It includes things like export packaging, documentation, and delivery. The only costs not generally included in FOB are shipping and import fees.
Landed cost includes any expenses associated with shipping a product. Put simply, landed cost is a more comprehensive metric than FOB.
The five landed cost components you need to track include the product price, shipping cost, customs and clearance fees, inventory risk, and overhead costs. Collect accurate data for all of these components to run landed cost calculations.
The product price is the cost of obtaining raw materials or merchandise from a supplier.
When you’re ready to price the product for consumer consumption, you will include those initial expenses, as well as any internal factors, and your target profit percentage.
Whether you’re shipping packages domestically or internationally— crating, packaging, handling, and transportation fees are some standard shipping costs you’ll likely encounter.
In most cases, you can preemptively calculate shipping costs by weighing the package, measuring its dimensions, and reviewing your selected carrier’s rates.
You will accrue customs clearance fees whenever you import or export products between different countries. These expenses include taxes, harbor fees, brokerage fees, tariffs, levies, and customs duties.
There are many types of inventory risk, but the primary concern among most business owners is the probability that not enough people will buy their merchandise, forcing them to accumulate backstock and set lower prices.
Tip: When calculating inventory risk, also include any additional costs associated with inventory protection like insurance, compliance, quality assurance, and safety stock.
Any ongoing business expenses create overhead costs. Some examples include:
Once you have a better understanding of your fixed, variable, and semi-variable overheads, you can optimize processes, reduce indirect cost, and confidently allocate funds for necessary company expenditures.
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Calculate your landed costs to determine how much money you’re spending on shipping during the manufacturing and final delivery process. The landed cost formula is:
Let’s go over a landed cost example so you can see the formula in action. For our purposes, you are an artist selling wall prints.
Now, assuming we’ve already calculated your unit cost and the amounts listed below are your expenses, we can get started. Here are your expenses:
Unit cost: $15/unit (30 total units)
Shipment cost: $45 or $1.50/unit
Customs: 2% or $0.04/unit
Risk: $3.75/unit
Overhead: $2.50/unit
$15 + $1.50 + $.04 + $3.75 + $2.50 = $22.79
In this scenario, your total landed costs are $22.79.
To make a profit, you would need to price your artwork higher than that sum.
As you can see, leaving out even one portion of this equation could affect how you price your merchandise and cause major damage to your bottom line.
Lower your shipping costs to keep profits high.
Strive to keep landed expenses around 15-20%, and keep in mind that shipping will likely eat up a substantial chunk out of your budget.
Ultimately, your expenses will vary depending on carrier and freight forwarder fees and supply chain or staffing issues. It may also take new businesses that are ironing out warehousing operations, fulfillment details, and enterprise resource planning (ERP) some time to get situated.
Some things you can do to keep shipping costs low include:
Calculating landed costs by hand can be time-consuming and put your company at risk for accounting errors, especially if you have a lot of items or charges to include in your reports.
Invest in accounting software with landed cost features to automatically factor in expenses like insurance and freight costs. This will help ensure quick and accurate accounting and streamline inventory tracking.
From the time you order raw materials until the time you ship out orders, you should remain cognizant of your budget and track your expenses.
Since landed cost refers to shipping expenses while inventory carrying costs cover the cost of storing your merchandise before it sells, you’ll need both to acquire comprehensive data. When you combine all of your findings, you’ll have everything you need to set a purchase price and meet profit targets.
Landed cost starts with ordering raw materials from your supplier, sending them to your factory or manufacturer, and shipping the products back to your warehouse where you can sell or deliver them.
Once you place that initial order, you will need to begin calculating any inland, air, or maritime transportation fees, currency conversion rates, handling fees, duties and tariffs costs, taxes, and other shipping costs.
The true cost is a combination of vendor, transportation, shipping, handling, customs duties, shipping insurance, and carrying cost expenses.
By managing your inventory value, landed cost, and carrying cost—you can better protect your profit margins.
Use the cost of goods sold (COGS), to assess your company’s financial health manually or with a profit margin calculator. Once you have that number, you can complete the gross profit margin formula:
Now, let’s practice using this formula with a profit margin example. If you sell quilts for $80 and they cost $35 to make, you will have a gross profit of $45 for each blanket.
In this case, your gross profit margin would beby 56.25%. This is an excellent profit margin, as most businesses consider anything over 20% to be high.
As you track your inventory, keep product profitability and inventory valuation in mind.
Product profitability refers to the amount of revenue you still have after paying to produce, hold, sell, and sometimes maintain stock. Inventory valuation is an accounting practice used to determine the overall value of unsold stock.
Some inventory valuation methods you can use include:
Tip: Take note of which inventory sells the best so you can avoid ordering unsellable inventory or merchandise that may become obsolete or age poorly.
First in, first out (FIFO) is one of the most popular inventory valuation methods for calculating inventory value and COGS. This is because your company is less likely to lose money if you make selling older perishable products first a priority.
The weighted average—or average cost—averages the face value of all stock and divides that amount by the total cost of those purchases. To use this method, you’ll need to account for your latest stock shipment, prior purchases, and all in-stock quantities.
If your landed costs are climbing higher than expected, your natural reaction might be to mark up your prices to pad your profit margins. However, a thorough audit of your landed cost can help you increase your profits without asking your customers to pay more.
Some extra fees that go into the landed cost, like taxes, are out of your control. But there are a few things you can do to keep costs under control:
Surprise fees during the production and distribution process are some of the most common causes of high landed costs.
To ensure you’re getting the best value, compare what you’re paying for third-party logistics (3PLs), distribution centers, and shippers versus other options on the market. If you’re happy with your current partners, you can try to negotiate better rates with them, especially if your supply chain partnerships are strong.
An unorganized warehouse can lead to costly supply chain problems. If you’re holding too much safety stock or your staff can’t find items in a timely fashion, you could save a bundle by creating and refining a simple solution.
Instead of relying on clunky spreadsheets to analyze your stock, leverage warehouse management software to get real-time insights and custom reports so you can identify weak spots before they hurt your bottom line.
Currently, only 6% of companies report having full supply chain visibility, which places 94% of businesses in a spot where it’s difficult to accurately evaluate costs and lower inventory expenses.
The good news is that by incorporating tech-forward and reliable inventory management software and taking back control of the supply process, businesses can reduce expenses from 9% to 4% and double their profits.
Ultimately, revamping your current practices will help your business eliminate backorders and minimize excess stock. Inventory management software can also help you plan purchases from wholesalers and manufacturers, take advantage of early order discounts, and view forecast trends.
A purchase order refers to an official order document drafted by a buyer promising to pay for requested products. Purchase order management is an internal process organizations use to obtain necessary products while justifying and optimizing costs.
Purchase order management is an important part of maintaining a budget and meeting procurement goals. Here are some things you can do to keep your company on track when executing purchase orders:
If you’re generating demand from countries outside of the U.S., consider variables like shipping, handling, insurance, and customs-related fees. To keep your customers happy, find the fastest, safest, and most affordable delivery option to ship your products.
Before you start shipping abroad:
Any shipment that weighs more than 150 pounds is considered freight and generally costs a flat rate to ship. Shipments that weigh less than that are classified as parcels or less than truckload (LTL) and are priced by weight and package dimensions.
If you’re willing to send your packages separately, you may qualify for multiweight shipping and a lower price.
The most common ways for businesses to ship packages are by:
Finding a speedy and reliable shipping service that offers fair freight rates and won’t damage your products en route is a struggle most business owners are all too familiar with.
If you’re in the market for a cargo shipping service, try to form a relationship with a company that values communication, shipment safety, prompt delivery, customer service, quality tracking software, and professionalism.
Look into these shipping companies known for helping small businesses meet their goals and keep customers happy. These shipping companies are the best for:
Customs-related fees like import duties and taxes are in place to protect small and local businesses by making products coming in from outside of the country more expensive.
These policies also safeguard jobs, residents, the economy, and the environment from harm. Depending on the items you’re shipping and where you’re sending them, these fees can rise or fall drastically.
Most countries set import taxes and duties rates based on the following criteria:
Canada, Singapore, Australia, New Zealand, and countries in the European Union (EU) apply either a goods and services tax (GST) or a value-added tax (VAT).
More commonly known as Uniform Capitalization Rules or UNICAP, 263a mandates that taxpayers capitalize direct and indirect costs to property they produced or obtained.
This means that, as the taxpayer, you would need to record the cost of an expense over its lifetime to show depreciation and amortization on direct and indirect costs.
Costs that 263a requires to be capitalized include:
Anything that has a relationship to inventory production or the resale of an item should be documented on your company’s balance sheet. Taxpayers that are classified as a “small taxpayer” aren’t required to adhere to these statutes.
International shipping insurance isn’t legally required, but it does protect you and the buyer in the event that the product you ship is damaged, lost, or stolen.
Most global trade carriers will automatically offer up to $100 USD of coverage. However, if you want additional financial protection, you will have to purchase it.
Before shipping your products out of the country, double-check that you are complying with U.S. federal regulations as well as those mandated by the country you will ship to.
Important compliance guidelines that you should consult include:
Freight shipment fees are generally divided out by charges applied before main transit, during, and once the cargo reaches its final destination.
Additional charges that you may encounter include:
Whenever you produce and distribute merchandise, you will encounter an untold number of business-related expenses.
Keeping a close eye on your costs allows you to act swiftly and with confidence based on the information from your accounting system. One of the best ways to reduce those costs is to carefully track your inventory in real time and to run inventory turnover ratio calculations regularly.
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