How do I calculate my true cost (“landed cost”) of products? This is a question we frequently hear, and it’s based mainly on three areas of uncertainty:
- What costs should I take into account?
- What if I only get the true costs on invoices long after the shipment arrives?
- How do I apportion these costs across multiple items on the same shipment (and deal with currency exchange rates)?
Although proper landed cost tracking software will be able to do the calculations for you, let’s take a quick look at each of the above questions, and try to demystify the Landed Cost Formula.
1. What costs should I take into account?
Beyond the obvious – the price I’m paying the supplier of the products I’m purchasing – the basic rule of thumb is to include all costs directly incurred in getting those purchased products into your warehouse. This would typically include, at a minimum, freight costs. For imported products, there’s often duty and brokerage costs. Others include insurance, storage costs, purchasing agency commissions and other regulatory fees.
2. What if I only get the true costs on invoices long after the shipment arrives?
With factors like freight, that’s often the case. In order to calculate a true landed cost at the time you receive a shipment, you’d have to use estimates for many of the non-supplier costs. For so many business reasons, it’s critical that you have a very clear idea of likely costs before you incur them, so any well run business should have no real problems coming up with estimates that are very close to the actual costs. Then the key is to have a good process for reconciling the actual bills (when they arrive) against the estimates you’ve used – something that a good ERP Inventory Accounting Software system should facilitate.
3. How do I apportion these costs across multiple items on the same shipment?
The best approach to apportion a cost factor over multiple different products on the same shipment is to use the calculation method that most closely mirrors the way that cost is constructed. For example, duty is usually very simple, as it’s a straight percentage of the value – so that’s how you’ll apply it, using the appropriate percentage(s). Freight would typically be pro-rated based on either weight or cube, depending on how the carrier charges for transportation. And it is of course important to factor in currency exchange rates, because it’s not uncommon for importers to be incurring costs in two or more currencies. For currency conversion, assuming you have not hedged currencies, the guidelines say to use the exchange rate on the date of receipt of the goods.
Example of a Landed Cost Formula:
Facts for 100 Widgets received as part of a shipment:
- Supplier cost: $25 per unit
- Duty applicable at 2%
- Freight cost for the entire shipment was $1,200 – and the widgets represent one quarter of the shipment by cube
In this case the formula for each unit would be:
$25 + (2% X $25) + (($1,200 X 25%) / 25) = $37.50