Understanding Landed Costs & The Profit Margin Formula

Written by Julie Stevens on 12 October 2017

Understanding Landed Costs & The Profit Margin Formula

Understanding landed costs is essential for retailers looking to understand their gross margin and to ensure accurate profit analysis. Understanding the gross margin means that you can work out at what point you break even, and then how much profit you'll earn after you’ve reached your break even point. 

But as a component of supply chain management, landed costs can easily be overlooked or not even considered until later on in the reporting process. By considering landing costs during supply chain management, it can help to make sure items will be profitable after they are imported. This article explains the basic formula that you can use to calculate your profit margin.

Understanding Landed Costs

So you’ve just bought your latest batch of high end products and you can see the profitability and margin will be something to make you smile. But is that item really as profitable as you think? Yes, you got that great price from your overseas seller and you know they will sell, but the price you pay is not really the true cost to you, affecting your margin. You may not be seeing the true picture.

As well as the actual cost price paid to the supplier, there may be other direct costs that need to be included in your profit calculations - particularly if the product is being imported as these additional costs can significantly affect the margin achieved.

Import duty, freight and insurance are all examples of direct costs that need to be taken into account when calculating the gross margin. They are not as straightforward as the actual cost price paid to the product’s supplier though – they frequently apply to a container rather than an individual product and they are paid to different suppliers at different points in time. The costs will also vary between shipments, so some units of a product will have one cost, while others that have been received in a later shipment will have a different cost. 

You need to make a decision about how best to split container-wide costs between the different units in that container and then be able to calculate and keep track of the true cost per unit of stock – the ‘landed cost’.

Most businesses will pay for the goods and then receive any additional costs as invoices from the freight company or the insurance company. These will be added to your accounting and at the end of the year, you see the total and if all goes well, you make a healthy profit.

Knowing the landed cost provides you with an accurate gross margin on every unit of stock, which then allows much more accurate reporting and data that can be relied on to make key business decisions.

Take a look at how Brightpearl handles landed costs in this demo video:

 

Landed Costs Example

Say you buy and sell two different types of widgets – widget A and widget B. You source both of them from the same supplier in China; paying $5 a unit for widget A and $7.50 a unit for widget B. You subsequently charge $12 for widget A and $15 for widget B.

Without taking into account landed costs, the gross margin on widget A is 41% (profit of $5 divided by $12 selling price) and the gross margin on widget B is 50% (profit of $7.50 divided by $15 selling price).

To get to the correct gross margin however, you need to take into account your landed costs rather than just the unit price you're paying to your supplier.

You order 1,000 units of widget A and 500 units of widget B and they arrive in the same container with a freight cost of $1,500 and an import duty cost of $875.

Firstly, you need to decide how to attribute the freight and duty costs between the two different products. You decide that the freight cost will be apportioned based simply on quantity – so widget A has a total freight cost of $1,000 ($1 per unit) and widget B has a total freight cost of $500 ($1 per unit). The duty cost is apportioned on value – so widget A has a total duty cost of $500 ($0.5 per unit) and widget B has a total duty cost of $375 ($0.75 per unit).

The landed cost of widget A is now the original cost of $5 plus the additional freight and duty costs giving a total landed cost of $6.50.

The landed cost of widget B is now the original cost of $7.50 plus the additional freight and duty costs, giving a total landed cost of $9.25.

Using these landed costs, more accurate gross margin figures can now be calculated. The new gross margin for widget A is 46% (profit of $5.50 divided by selling price of $12) and the new gross margin for widget B is 38% (profit of $5.75 divided by selling price of $15).

These gross margins give you a much better insight into your cost of sales and allows you to make better informed decisions around your stock and sales of the different products. It also allows you to look in more detail at your true landed costs to see where any cost savings could be made.

 

Landed Costs: Providing a True Picture of Your Profitability

Landed costs allow you to start adding those additional costs to your products, building up the cost price, allowing you to see a more accurate margin and allowing your sales team to see what prices can be offered to customers. It allows you to see when all is taken into account, if purchasing overseas or from certain suppliers is a better option than buying locally. Or does selling that item on sales channel X still make a sensible selling option when you take into account the extra costs for your products and the selling prices on that channel?

Landed costs give you the ability to start adding a more accurate level of pricing to your goods that flows through to all areas of your business. Your sales staff can see how much they can discount products while still maintaining a profit, your inventory values are more accurate on the balance sheet, you can start seeing if selling on channels like Amazon and eBay with their associated fees are still a viable option, and it can start shaping your buying decisions.

If you have the choice between two suppliers and one seems to be cheaper by 5%, but there are now extra costs for shipping and insurance, it actually may be more expensive to you. Knowing your true costs allows you to see if and when this is the case.

Ultimately, it's clear to see why knowing your landed costs is crucial to any growing retail business.

To find out more about how landed costs can help your retail business, visit our app store or book a demo today!

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Julie Stevens
About the author
Julie Stevens

Julie Stevens is Managing Director at Evenstone Ltd. Evenstone are accountants who specialise in helping people get the most out of their Brightpearl accounting through monthly support packages, ad-hoc services or training.