Why an importing wholesaler sees a 39 percent margin on an item that yields 25 percent after freight, import duty and currency

In March, the buyer at a technical wholesaler places an order with a manufacturer in China: 740 units of an item at $46.20 per unit, delivered on board in the port of Shanghai. At that day's exchange rate this is €42.00. The selling price is €69.00, so the costing shows a 39 percent margin, well above the 33 percent the company uses as its floor. In July the item is in the warehouse and in August it goes out of the door. At the end of the year the annual accounts show a gross margin of 30.9 percent on revenue of €9 million, and the managing director looks for the explanation in the sales department, which is supposedly giving too much discount.

The explanation lies elsewhere. Between the manufacturer's invoice and the shelf in the warehouse, six cost items have been added, and all six have been booked to a separate general ledger account: freight costs, import duties, exchange differences, warehouse costs. None of those items ever reached the item. The costing works with €42.00, reality with €51.95.

The purchase price on the invoice is the starting point of the cost price; the margin per item an importer sees in his system is therefore structurally too high, and the difference is hidden in the expense lines below gross margin.

Why costs end up in the wrong place

Cooper and Kaplan (1988) described in Harvard Business Review (trade journal) why companies with many products base their pricing and product mix on distorted cost information: indirect costs are spread over all products with a single mark-up, while in reality the products cause those costs very unequally. Their solution, activity-based costing, allocates costs to what actually causes them. Quesado and Silva (2021) analysed 1,419 publications on that method in the Journal of Open Innovation (peer reviewed) and describe it as having emerged to correct the distortion of traditional cost allocation with a more accurate allocation of indirect costs.

For an importer that inequality sits in the container. A container with 740 units of a heavy €42 item costs as much freight as a container with 12,000 units of a light €9 item. Per unit that is a difference of a factor of sixteen. If you divide the whole year's freight by the whole year's purchase value and put that mark-up on every item, you make the heavy item too cheap and the light one too expensive.

Ellram (1995) defined total cost of ownership in the International Journal of Physical Distribution & Logistics Management (peer reviewed) as a method that looks beyond the price of a purchase, and on the basis of eleven company cases classified the calculation models by how buyers use them: when choosing a supplier and when evaluating afterwards. Pumpe and Vallée (2017) built on this in Transportation Research Procedia (peer reviewed) with interviews with 24 purchasing and supply chain managers about international sourcing, and developed a classification of total landed cost methods by accuracy, because not every international sourcing situation needs the same calculation model.

At importing trading companies we see that the accounting package does know the additional costs, but nobody puts them on the item. The freight invoice arrives three weeks after the goods and is booked to "transport costs". The customs declaration goes through the forwarder and the import duties are on his invoice, among the clearance costs. The exchange difference arises on the day of payment and ends up in "exchange result". The hours spent receiving goods in the warehouse disappear into wage costs. Each of those entries is correct in itself, but none of it reaches the item.

On what amount you pay import duty

Import duty is a percentage of the customs value, and that customs value lies between the manufacturer's invoice and the total landed cost. The Douane (Dutch Customs, Handboek Douane, government source) prescribes that the price actually paid is increased by the costs of transport and insurance up to the customs territory of the Union. So the sea freight to Rotterdam counts, the onward transport from Rotterdam to your warehouse does not, and neither does receiving into your own warehouse. If you let the forwarder add everything up, you pay too much duty; if you only declare the factory invoice, you pay too little and risk a supplementary assessment.

Import VAT is a different story. With an article 23 licence (vergunning artikel 23), according to the Belastingdienst (Dutch Tax Administration, government source) the VAT on import is reverse-charged to the periodic VAT return, where you declare it and deduct it at the same time. For a VAT-registered business, import VAT is therefore not a cost and does not belong in the landed cost. Without that licence you do pay the VAT at the border and only get it back in the return; that affects your cash, and the cost price does not change. Whether your company qualifies for that licence and what the conditions are is a question for your tax adviser; we do not give tax advice.

Worked example: from €42.00 to €51.95

In this worked example the wholesaler buys the item FOB Shanghai, so the manufacturer puts the goods on board and from that moment freight and risk are for the buyer. The Incoterms 2020 van de ICC (International Chamber of Commerce, industry organisation) set out per delivery term who bears which costs and which risk; the term you choose determines which cost items appear on your invoice and which are in the supplier's price.

The order: 740 units at $46.20. On the day of the costing the dollar stands at 1.10 to the euro, so €42.00 per unit. The company pays 30 percent with the order and 70 percent on shipment, ten weeks later. On that second payment day the rate is 1.06. The first payment costs 0.3 times 46.20 divided by 1.10 is €12.60 per unit, the second 0.7 times 46.20 divided by 1.06 is €30.51. Together €43.11. The exchange difference is €1.11 per unit, and in the accounts it sits in exchange result.

The container: sea freight Shanghai-Rotterdam costs €3,900 in this example, port costs, documentation and clearance €650 and onward transport to the warehouse €480. Together €5,030, divided by 740 units is rounded €6.80 per unit. Transport insurance is 0.3 percent of the value of the goods, €0.13 per unit.

Import duty: in the example a rate of 2.7 percent applies to this item. The customs value per unit is the price paid of €43.11 plus the sea freight of 3,900 divided by 740 is €5.27 plus the insurance of €0.13, together €48.51. The duty is 2.7 percent of that, €1.31. Had the forwarder also included the onward transport and port costs, it would have been €1.35; on this order that is €30 too much, on a year's purchases of €5.6 million such an error runs into the thousands.

Receiving: receipt, inspection, labelling and putting away cost the warehouse €0.60 per unit in this example. That is an internal cost, and the only one of the six that you will not find on an invoice.

At a selling price of €69.00, the margin on the costing price is 27.00 divided by 69.00 is 39.1 percent. On the landed cost it is 17.05 divided by 69.00 is 24.7 percent. The additional costs are €9.95 per unit, 23.7 percent on top of the purchase price. If the company wants to achieve the 39 percent on this item that the costing promised, the selling price has to go to 51.95 divided by 0.61 is €85.16.

What the average hides

The company in the worked example has 400 items in its core range, revenue of €9.0 million and a cost of sales of 5.6 million. The additional costs over the whole year, so all freight, duties, insurance, exchange differences and receiving together, are €617,000. That is 11.0 percent of the purchase value. The managing director who makes this calculation thinks he is done: every item gets an 11 percent mark-up and the cost price is right.

Calculate one level lower, per item group, and the picture changes. In this worked example the range is grouped by value per cubic metre. Group A contains the heavy, cheap items: cast iron, steel, fasteners. Opposite that is group C, light and expensive: measuring instruments and electronic components. Group B sits in between. For the heavy goods the actual additional costs are 26 percent of the purchase value, for the light ones 2 percent.

At the bottom line every method comes to 30.9 percent. Per group they diverge by tens of percentage points. Group A carries €210,000 more in additional costs than the average mark-up allocates to it, group C €144,000 less. The salesperson who refuses a 5 percent discount on group C because "the margin would drop below 33" loses an order that would have yielded 39.6 percent. On group A the opposite happens: the system says 30, so the salesperson may go down to 22 percent, and after the actual additional costs the company keeps almost nothing on that order.

Go one level lower still, to the 120 heaviest items within group A. Together they make €1.1 million of revenue on €850,000 of purchase value, a margin of 22.7 percent in the system. Their actual additional costs are 34 percent, €289,000. The landed cost of those 120 items is €1,139,000, which is €39,000 more than the revenue. The company sells 120 of its 400 items below cost price, and the annual accounts show a gross margin of 30.9 percent that alarms nobody. How to get the bottom of your range into view and what the risk is if you do not is covered in The Pareto principle is also a risk gauge for your business.

Why timing distorts monthly profit

Timing also affects monthly profit. As long as the additional costs sit on expense lines, they are taken in the month the invoice comes in. The €5,030 of freight for the container in the example weighs on the July result. The 740 units are sold from August to December. In July profit is therefore €5,030 too low and in the following months €5,030 too high in total. At a company that buys in spring for the autumn season, that effect can be tens of thousands of euros at monthly level, and then the monthly report says in May that things are going badly and in October that things are going well, while nothing has happened.

If the landed cost is on the item, the freight goes into inventory with the item and only enters cost of sales when the item is sold. Inventory on the balance sheet is then also higher, and rightly so: those 740 units cost the company €38,443, not €31,080. How a wrong cost price on the balance sheet feeds through into the profit you pay tax on is worked out in Why a hardware reseller pays tax on profit it does not have when memory prices rise.

What is acceptable and at which moment

A landed cost accurate to the cent per item is not the goal, and anyone who tries drowns in allocating one freight invoice over forty items in a single container. What we see as workable, in the order in which it sits in the purchasing cycle:

The moment that yields the most is the first: the costing. A selling price built on €42.00 can no longer be corrected once the item is in the price list. Everything after that is checking whether the estimate was right.

How to calculate landed cost per item yourself

The proper method is allocation per shipment: every freight and customs invoice and every payment to the supplier is linked to the items in that shipment, by weight or volume for freight, by value for duty and insurance, and receiving is allocated per receipt line as Kaplan and Anderson (2004) describe in Harvard Business Review (trade journal) with time-driven activity-based costing: the cost of the warehouse per minute, times the minutes a receipt line takes. Most ERP packages for trading companies can do this, and setting it up is the work we do for our clients, so it is also how we earn our money.

The do-it-yourself version takes an afternoon with last year's general ledger accounts and the item master data, and in five steps gives a landed cost per item group close enough to reality to correct the price list.

1. Add up last year's additional costs from the general ledger. Sea and air freight, port and clearance costs, onward transport, transport insurance, import duties, exchange result on purchasing and the staff costs of receiving in the warehouse. In the example: €617,000.
2. Divide the range into groups by value per cubic metre or per kilo. Four to six groups is enough. Take last year's purchase value per group. In the example: A 1,400,000, B 2,600,000, C €1,600,000.
3. Spread freight, port costs and onward transport by volume or weight per group, and duties, insurance and the exchange difference by purchase value per group. For the duties you need the average rate per group; it is on the forwarder's customs declarations. In the example group A comes to €364,000, B to 221,000 and C to 32,000.
4. For each group, divide the additional costs by the purchase value. That gives the landed cost factor: A 1.26, B 1.085, C 1.02.
5. Multiply the purchase price of each item by the factor of its group and put the result next to the selling price. Sort by margin in euros and look at the bottom. In the example there are 120 items with a negative margin there.

Once you have done this, you have a landed cost per group, and that makes the difference between 11.8 and 39.6 percent visible. Allocation per shipment, which shows the difference per item, comes after that.

When this worked example does not apply

The model assumes an importer that buys outside the EU and arranges the freight itself. For a number of companies it is different.

A wholesaler that buys within the EU from distributors, delivered free to its door, has no import duty, no sea freight and no currency difference. The additional costs are then receiving and sometimes a freight surcharge, together often less than 3 percent of the purchase value. There one mark-up percentage for the whole range is good enough, and this article is an exercise that yields nothing.

A company that buys DDP, so with all costs up to the warehouse in the supplier's price, already has the landed cost on the invoice. There the problem is on the other side: the supplier has built the freight, the duty and his own currency risk into the price with a margin on top, and the importer does not know how much. At companies switching from DDP to FOB we see landed cost fall, but only if they have the allocation above in order. Otherwise the saving disappears into the expense lines this article is about.

A range in which the additional costs weigh about equally on every item, for example because everything comes from the same factory in the same container and has roughly the same value per kilo, is fine with a single average. The error only arises from the spread around the average.

And the model works with a currency difference that arose between costing and payment. A company that fixes the rate at order with a forward contract at its bank, or that buys in euros, does not have that item. What it does have is a supplier who has built the currency risk into his dollar or euro price. How a price risk between quotation and purchase squeezes margin is worked out for a machine builder in Why a machine builder with fixed prices loses its margin to a steel price rise between quotation and purchase.

How to get the margin per item of an importing wholesaler in order

Calculate the landed cost factor per item group with the five steps above, and put that factor into the system in which selling prices are calculated. In the example, the costing of the item then changes from €42.00 to €52.92, and the floor for the salesperson from €62.69 (42.00 divided by 0.67) to €79.00.

Check the customs value on your forwarder's declarations against the Customs rule: price paid plus transport and insurance up to the EU border, without onward transport and port costs. In the example the difference is €0.04 per unit; on €5.6 million of purchases at an average rate of 2.7 percent, a wrong basis can make a difference of thousands of euros per year, and a supplementary assessment if it is wrong in the other direction.

Link every freight invoice and every customs invoice to a shipment number before it is booked. This is an administrative agreement with the forwarder and with your own accounts payable team, and it needs no software. Without that link, allocation per shipment cannot be done later. This is our own experience at trading companies.

Keep the exchange difference on purchasing separate from the rest of the exchange result. In the example it is €1.11 per unit, 2.6 percent of the purchase price, and that amount belongs in the cost price. Whether you fix the rate at order is a separate decision after that; this article is about measuring it.

Every quarter, look at the 10 percent of items with the lowest margin in euros after landed cost. In the example that is 40 items, some of them below cost price. Per item there are four outcomes: raise the price, a cheaper delivery term or supplier, a larger or smaller order quantity, or drop the item. How interest on that inventory makes the calculation heavier still is covered in What the ECB rate rise costs a technical wholesaler that lets its customers pay in 52 days.

Include landed cost in the cash forecast. You pay the import duties at the border, the freight within thirty days, receiving monthly through wages, and the 70 percent of the factory invoice on shipment, ten weeks before the item is in the warehouse. In the example, the invoices to customers only go out five to nine months after the first payment, and the money comes in a month and a half after that. Why a growing trading company runs out of money while making a profit as a result is covered in Why a profitable SME still gets stuck on cash flow.

On the tax side this subject touches on a few questions you should put to your tax adviser or customs adviser, because we do not advise on them: whether an article 23 licence is possible for your company and what it requires in terms of administration; whether the tariff classification (the commodity code) of your main items is correct and whether a preferential rate applies under a trade agreement with the country of origin; how you should value inventory for tax purposes if the additional costs are on the item from now on instead of on the expense lines; and whether the exchange difference on purchasing belongs in that inventory valuation for tax purposes or in the result for the year.

Frequently asked questions about landed cost at an importing wholesaler

How do I calculate the landed cost of an imported item?

Add to the purchase price paid all the costs needed to get the item into your warehouse: sea or air freight, port and clearance costs, onward transport, transport insurance, import duty and receiving into your own warehouse, and spread each item of cost over the items in the shipment by weight, volume or value. In the worked example, €42.00 purchase price becomes €51.95 landed cost: €1.11 currency difference, €6.80 freight and handling, €0.13 insurance, €1.31 import duty and €0.60 receiving.

Why is my margin per item lower than my costing says?

Because the costing uses the purchase price on the supplier's invoice, while freight, duties, currency differences and receiving sit on separate expense lines in the accounts and never reach the item. The gross margin of the company as a whole is then correct, 30.9 percent in the example, but the margin per item is too high: 39.1 percent in the system against 24.7 percent in reality.

Do freight costs and import duties belong in the cost price or in overhead?

In the cost price. They arise from purchasing a specific item, they differ per item by a factor of ten or more, and without them you cannot calculate a selling price. Cooper and Kaplan (1988) described this kind of cost as the reason why companies with many products base their product mix on wrong information. Overhead is what you cannot link to an item: the office rent, the managing director's salary.

How do I spread the costs of a container over the items in it?

Freight, port costs and onward transport by the volume or weight each item takes up in the container; insurance and import duty by value. In the example there is one item in the container, so all €5,030 of freight and handling goes to those 740 units. If there are forty items in it, an item that takes up 5 percent of the volume gets 5 percent of the freight and an item with 5 percent of the value gets 5 percent of the duty.

Is import VAT a cost for my business?

Not for a VAT-registered business. With an article 23 licence the import VAT is reverse-charged to your VAT return, where you declare it and deduct it at the same time. Without that licence you pay it on import and get it back in your return; then it is a cash question. Import duty is a cost, because you do not get it back. Whether you qualify for the licence is a question for your tax adviser.

On what amount do I pay import duty?

On the customs value: the price actually paid plus the costs of transport and insurance up to the external border of the EU. Onward transport from the port to your warehouse and your own receiving are not included. In the example the customs value is €48.51 per unit and the duty at 2.7 percent is €1.31.

Which delivery term is cheapest for an importer?

You only know that once you know the landed cost per item. Under FOB you arrange and pay the freight, insurance and clearance yourself and see each item of cost separately; under DDP they are in the supplier's price, with his margin and his currency risk included, and you see nothing. At companies switching from DDP to FOB we see landed cost fall, provided the allocation per shipment is in order. Without that allocation the benefit disappears into the expense lines.

What is a good gross margin for an importing wholesaler?

That depends on the item group, which is why the question can only be answered once landed cost is on the item. In the worked example the company achieves 30.9 percent overall, with 11.8 percent on heavy, cheap items and 39.6 percent on light, expensive ones. At importing trading companies among SMEs we see the average between 25 and 40 percent, and the spread between item groups is larger than the difference between companies.

Further reading: The Pareto principle is also a risk gauge for your business, Why a hardware reseller pays tax on profit it does not have when memory prices rise, What the ECB rate rise costs a technical wholesaler that lets its customers pay in 52 days and Why a profitable SME still gets stuck on cash flow. New: Why a technical wholesaler pays €98,000 every year for €396,000 of inventory that has not moved in twelve months, Why an importing wholesaler with €9 million revenue pre-finances almost €3 million and is overdrawn despite making a profit and Why a technical wholesaler takes a €600 discount on an MOQ of 500 units and loses €1,225 on it.

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