Sometimes telling a prospective customer the truth can offend him / her, but not doing so can ultimately do both of you a disservice. If you’re thinking of buying my company’s Inventory Accounting Software, I believe it’s best for both of us that we address any inaccurate or inadequate business processes up front, to ensure that if you do implement our system, you’ll realize the maximum benefit.
Here’s a summarized version of a conversation with a business owner:
Me: “Tell me about your suppliers.”
Owner: “We mostly buy directly from the manufacturers, in Thailand, South Korea and India.”
Me: “Ah, so you’ll need to track landed costs.”
Me: “You’ll want to factor costs like duty, brokerage, freight and insurance into your inventory cost and cost of sales.”
Owner: “Not really. We just expense those items based on our broker’s invoices, and shippers, etc.”
Me: “Then how do you establish selling prices and track your gross margins?”
Owner: “We just use the price we pay the supplier as our cost, and mark that up by the target percentage.”
Me: “So you’re OK with potentially losing money on certain products without knowing it?”
Owner hung up.
Hopefully you already see what the business owner was missing. Those additional costs, incurred solely to get saleable product into your warehouse, are part of your inventory cost. If you buy a widget for $100, and sell it for $125, you’ve made a $25 gross margin. Seems worthwhile. But if you paid $12 in duty, $5 in brokerage and $9 in freight costs to get the product, did you still make money on it?
Many people confuse this with covering general business expenses. But costs such as rent and wages would exist anyway. However, the only reason you paid those duty, brokerage and freight costs was to get the product in so you could sell it. Therefore if you don’t cover those costs in your selling price, you’d be better off not having purchased it in the first place.
So why do so many small business owners continue to ignore these landed costs? Is it because their existing software does not support landed cost tracking? Is it because they’ve not thought this out? Or is there some other reason?