A vendor’s quoted price of an item is commonly referred to as the “replacement cost”. Many organizations make the mistake of basing their purchasing decisions and profitability analysis on this amount. But, in many cases, other costs are incurred when buying a product and preparing it for sale or use. These costs can include:
- Incoming freight
- Customs duties (if the goods are imported)
- Any other cost related to a specific purchase or shipment of a product
To make intelligent replenishment decisions, and accurately calculate profitability, these expenses must be added to the replacement cost. The result is referred to as the “landed cost”.
To calculate the landed cost for the products received in a shipment:
- Total all the expenses associated with a particular stock receipt, then
- Choose whichever of the following fits the situation:
- If the products are fairly uniform in cost, size and weight, divide the total expenses by the pieces received to calculate a cost per piece. Add this cost to the replacement cost for each piece. For example, if the total expenses for a shipment are $50 and 100 pieces are received, ($50 ÷ 100 pieces = $0.50). Add 50 cents to the replacement cost of each item to determine the landed cost. Thus, a product with a $15 replacement cost would have a $15.50 landed cost.
- If the items received have significantly different replacement costs, divide the total expenses by the total material value of the shipment to calculate a cost per dollar of material. Add this cost to the replacement cost for each piece. For example, if the total expenses for a shipment are $120 and $1,000 of material are received, add 12 cents for each dollar of the replacement cost of the items received to determine the landed cost ($120 ÷ $1,000 = $0.12). Thus, an item with a $10 replacement cost would have $1.20 added to it for a landed cost of $11.20.
- If the items received vary significantly by weight or cubic volume divide the total expenses by the total weight or cubic volume to calculate a cost per pound or cubic foot. Add this cost to each piece received based on that item’s weight or cubic foot. For example, if the expense cost is calculated to be 30 cents per pound and a piece of an item weighs 10 pounds, add $3.00 to the replacement cost to determine the landed cost of $13.00.
Utilizing the landed cost will ensure that you make more intelligent purchasing decisions. It will also help you better assess your profitability. Next month, we will explore how the quantity of a product you purchase will also affect your company’s bottom line.