Opening: The Hidden Cost That’s Eating Your Margins
You have just made a sale at your e-commerce shop. The customer then clicks on the checkout and a few seconds after, you are celebrating the revenue. But there, who is paying to transport that product of your warehouse to their homes? Whether the answer is you, then you are dealing with freight out costs. All these costs in shipping can silently eat your profit margins unless you know how to keep track, record and optimize on them. Freight out may appear as an additional line in your accounting accuracy, cost management and ultimately your bottom line. This guide will bring clarity on what freight out is actually, how to correctly record it in your books, and what of the actual actionable strategies that can make sure you control these costs so that you can preserve your margins and make wiser business decisions.
1. Definition & Basics: Understanding Freight Out
Freight out also describes the costs that a seller faces in transporting goods to his or her customers. It is that cost that you incur in transporting your goods wherever that may be the warehouse, distribution center or retail store to the final consumer destination. It is a factor which is an outbound shipping cost that occurs following a sale.
Freight out is a wider term of freight and transportation costs but it is limited to finished goods which no longer remain under your control. Imagine it to be the last mile cost in your supply chain- the last mile, which moves your product to the hands of the customer. Regardless of whether you are on FedEx, UPS, DHL, or a dedicated carrier of freight, these delivery costs are included in your freight out costs.
Freight in on the other hand is the reverse: It is the expense of delivering items to you when as a buyer you are the recipient. As you acquire inventory products at the supplier and have them ship to your warehouse, these inbound transportation costs are freight in. It is important to understand this distinction since each type of freight expense is treated differently by accounting and has its own financial statement impact.
2. Why the Distinction Between Freight In and Freight Out Matters
That distinction between freight in and freight out is not merely semantic, it also has serious accounting consequences that will directly influence how your business performance will be reflected in your financial statements. Inventory cost is usually increased with the freight in. When placing goods on receipt and payment of shipping expenses, they are included in your inventory value on the balance sheet. They will not even affect your income statement until you sell those items as cost of goods sold (COGS).
Freight out, however is usually considered a type of operating expense and it will be shown under your income statement in the period in which it is incurred. It is usually listed under distribution costs or selling expenses and not a part of COGS. This treatment is based on the fact that freight out occurs once a sale transaction has been completed, as part of satisfying your delivery requirement to the customers.
We can use some figures to explain this, say you purchase 100 units of product at a cost of 10 each and the freight in charges cost you 200. The cost of your inventory is going to be 1,200 (1,000 + 200) or 12 per unit. In the future, you sell 50 units to a buyer at a price of 20 a unit, and you make 1000 dollars. You spend $150 in transporting those 50 units to the customer. Our COGS would be 600 (50 units multiplied by 12) and freight out of 150 would be posted separately as a selling expense. Your gross profit is 400, hence when you subtract the freight out expense of 150, what you have is an operating profit of 250. When you would have wrongly classified freight out as COGS, then your financial ratios would be inaccurate and profit margin calculations would be misleading your stakeholders on your operational efficiency.
3. How to Record Freight Out: Three Common Approaches
Freight out should be adequately recorded in your accounting system so that you can report your financial data properly and control your costs. Three of the most popular techniques, each having its own disadvantages and benefits, are listed here:
Method 1: Freight out is treated as a Separate Selling Expense This is the most simplest method of treating freight out as an operating expense. Your entry would be in your journal as follows, Debit Freight Out Expense (or Delivery Expense), Credit Cash/Accounts Payable. The approach gives a clear representation of the shipping prices in a separate line item and thus the distribution cost is easily tracked and analyzed with time. The downside? It does not directly associate the cost of shipping with individual sales transactions and this may complicate the product level profitability analysis.
Method 2: Adding to Cost of Goods Sold Some methods, especially those involving a large amount of outbound freight that the company incurs as a part of delivering products, prefer to add inbound freight out to Cost of Goods Sold. This method assumes shipping to be an inseparable component of product fulfillment. The advantageous side is that it makes overall cost of delivering products more complete and thus gross margin calculations become more significant. This is however contrary to normal accounting standards and can cause a difficult comparison to industry standards where freight out should be below the gross profit line.
Method 3: Freight Recovery (Passing Costs to Customers) You are passing cost to customers, whether it is a charge based on actual cost or standard amount, you are engaging in freight recovery. You enter as an expense (Debit Freight Out Expense) the amount you paid the shipping company and as revenue (Credit Shipping Revenue or contra-expense account) the amount you collected back as revenue. When you receive a customer payment of $20 and just pay the carrier $15, then the difference of $5 becomes extra margin. On the other hand, when you charge 10 and pay 15 you are subsidizing shipping by 5. This is the most detailed way but you need to closely follow it up, making sure that you are not systematically undercharging and eating costs that would otherwise be recouped.
4. Freight Out Across Different Business Models
The impact of freight out on your business is radically different whether you are operating in an industry sector or you are running in an operational model.
E-commerce and Retail: Freight out expenses are often an obligation of online sellers as a competitive requirement. Aligning with customer expectation, free shipping has either been taken up by retailers or factored into the costs of a product. The presence of Amazon has taken the fight to the next level, which means that other smaller e-commerce enterprises must provide free shipping beyond a certain order limit, or lose out on the conversions. This renders freight out management to be critical in ensuring profitability in online retailing.
B2B and Wholesale: Business-to-business deals tend to push freight out on to the purchase side. Such terms as FOB (Free on Board) destination or FOB shipping point define who will cover transportation expenses and who will own it when. Under FOB shipping point, freight expenses are paid at the location of the seller and in that way, the seller does not incur freight out expenses. In FOB destination terms, however, the seller is charged with freight expenses until the point when goods have reached a buyer.
International Shipping: Cross-border deals add complexity in terms of duties, tariffs, and other Incoterms (International Commercial Terms) which dictate exactly who bears freight charges, insurance and risk at every point. CIF (Cost, Insurance, and Freight) and EXW (Ex Works) denote that the former implies that the freight is paid to the port where the goods reach the buyer, whereas the latter implies that it is all the buyer’s duty to handle the transportation once the goods have left the premises of the seller.
Special Cases: Drop-Shipping businesses usually will have the freight out included in supplier costs, which is less conspicuous but has an impact on margins. Three-party logistics (3PL) vendors can also offload freight out as per-order fulfillment cost. Freight out costs are already covered in service fees in marketplace platforms such as Amazon FBA, which must be examined carefully to know the real cost of freight out.
5. Strategies to Manage and Optimize Freight Out Costs
Strategic management practices that do not interfere with customer satisfaction can be used to control and reduce freight out expenses.
Bargain Carrier Rates: Do not take published shipping rates as fixed. The carriers often contract on a basis of discounts with respect to shipping volume, engagement on contract or seasonal partnership. The advantages of comparison shopping between carriers or shipping aggregators can be used by even small businesses. Discounts of 15-30% of standard rates can be achieved by volume commitments annual.
Streamline Transportation and Route Choices: Not all deliveries need next-day air delivery. Examine your shipping data to compare your service levels up with the real customer demands. Compared to similar distances by express air, ground shipping is generally 40-60 per cent cheaper. Local deliveries can be made affordable by route planning software which is able to pack several stops at a time and save on the per-delivery expenses.
Smart Cost sharing with Customers: Although free shipping, which is universal, can be cost-consuming, use tiered strategies. Free shipping targets prompt larger order sizes- at an average order of $45 a target of free shipping at $50 would incentivize incremental revenue that would exceed freight expenses. Instead, provide customers with options: standard free delivery or paid express, allowing price-sensitive customers to wait as those who need it most, to self-select higher services.
Packaging and Consolidation: Dimensional weight pricing implies that large, light packages are priced higher than the actual weight of the package indicates. Right-sizing of packaging helps save dimensional charges greatly. Consolidating freight by keeping orders in transit so that multiple shipments serving the same part of the world can be loaded onto one truck can radically reduce the unit costs, especially where the B2B customers are concerned and where they do not demand rapid delivery but need to be provided with a low price.
Data-Driven Analysis: Monitor the percentage of freight out as a proportion of revenue by product category, destination zone, and carrier. This visibility shows products or regions that are disproportionately costly to serve and can be used to adjust pricing, or diversify suppliers. Monthly trend analysis will help you notice increases in rates fast and re-negotiate or change carriers before the cost becomes out of control.
6. Common Misconceptions and Pitfalls to Avoid
There are a number of common errors that may compromise your freight out management and financial accuracy.
Misconception 1: Freight Out Is a Constant operating Cost Although standard accounting records it as such, businesses occasionally must consider whether or not freight out ought to be regarded as informing COGS calculations. When the cost of shipping your products is 20 percent of the price of delivering the product, not factoring it into the product profitability analysis is like flying blind on what products actually generate profit.
Pitfall 1: Double-Counting of Shipping Costs This happens when freight out costs are recorded as a separate cost and at the same time recorded as part of the inventory cost or COGS. Close balancing of inventory receipts (freight in) and customer deliveries (freight out) helps to avoid this mistake.
Pitfall 2: Not re-pricing products due to freight Reality Most businesses calculate product prices with reference to product costs and the desired margins without considering freight out costs properly. When you are taking in 8 dollars shipping on a 40 dollar product with a 40 percent gross margin, then you may be making a thin profit after freight or at a loss. Pricing reviews that include the average freight out costs per group of product should be done regularly.
Pitfall 3: Forgetting Freight out When starting with 50 orders a week a business scaling up may frequently handle freight out by hand and inefficiently. Those inefficiencies are exponential when that is multiplied by 500 orders a day. Not investing in freight management systems, integration of carriers, or forming 3PLs as you grow implies that freight expenses rise at a higher rate than revenues, squeezing margins at just the time you are supposed to be increasing them.
7. Real-World Example: How One Business Transformed Freight Out Management
Take an example of a fictional online store “GreenHome Goods” which sells environmentally friendly household goods. To begin with, they provided free shipping on all of their orders to compete with bigger retailers, which cost them around 12-15 per order in freight out. Having average order values of 55 and product costs that constituted 60 percent of the revenue, they had very thin margins of about 8 percent after freight out.
The Analysis: GreenHome analyzed 6 months of shipping data and found out three main things. To begin with, 40 percent of orders were less than $40, that is, freight out swept up close to half of their gross profit on such orders. Second, a quarter of customers were literally choosing products by availability, not by price, which indicated a view that speed of shipping was important, not free shipping. Third, they were operating with one carrier who charged close to retail rates.
The Solution: GreenHome has adopted a three part approach. They added a 50 dollar free shipping bar and charged 5.99 flat rate shipping on smaller orders. They also made deals with two other carriers and gained 22 per cent average rate cuts through volume division. Lastly, they optimized packaging where the average package size was reduced by 18 percent and this decreased dimensional weight payment.
The Results: In the next quarter, the average order value rose to $63, compared to the previous quarter of 55, provided that the customers added something to get free shipping. The cost of freight out per order fell to $13.50 to 9.20. Together with the higher order values, their net profit margin has gone up to 14.5 against 8% initially. In fact the customer satisfaction scores went up a notch, because of the increased speed of the carrier choices and clear shipping policies that inspired trust. The lesson? Freight out need not be a profit killer, it can be a competitive advantage with strategic management it becomes a cost centre.
8. Freight Out and Tax Considerations
This knowledge about the tax consequences of freight out costs makes compliance and best financial management possible. Under most jurisdictions, freight out expenditures are completely deductible as ordinary business expenses during the year incurred and lowers taxable income. But when you charge customers individually shipping, that sum is usually a taxable revenue, however, in certain jurisdictions the shipping charges listed separately are generally not subject to the sales tax as long as the goods underlying these charges are tax-exempt.
Documentation is crucial. Keep good records and distinguish between freight out and product costs and support with invoices by carriers. When you are in a foreign country, remember that shipping charges are not treated in the same way by VAT and GST, depending on the country that we are in; some treat shipping as part of the overall sale and others do not charge shipping at all.
In the case of businesses which perform accrual accounting, freight out must be recorded during the same period as the corresponding sale so that expenses are matched to revenues. Cash-basis firms recognize freight out as it is due and this is easy, however, may misrepresent period-to-period profitability where shipping payment timing significantly differs with the sale timing.
9. Technology Solutions for Freight Out Management
The tracking of freight out, optimization and cost control is made completely easy by the modern technology. Transportation Management Systems (TMS) is what automates the process of selecting carriers according to the parameters of cost, speed and reliability which you define. These systems are connected with your e-commerce or ERP system and automatically retrieve order data and create shipping labels and real-time cost tracking.
Shipping packages such as ShipStation, Shippo or EasyShip can instantly compare the rate of a dozen or more carriers, making sure you never pay more than competitive prices. These are often provided at reduced rates due to their carrier alliances, occasionally at 20-30 per cent below what direct carrier relationships would be costing to smaller shippers.
The API integrations link your shopping cart, warehouse management system, and accounting software so that the freight out costs pass directly into your financial records automatically without any manual data entry. This automation eliminates errors and offers real-time access to shipping costs as compared to budgets.
The trends of freight out are visualized in analytics dashboards and the cost outliers, carrier performance problems and consolidation opportunities or route optimization are highlighted. Freight out expenses in the future can be predicted based on projections of sales and can help you budget and price products accordingly, with predictive analytics.
10. Future Trends in Freight Out Management
Due to technology innovation and new customer expectations, the freight out landscape is changing at a high rate. Drones and self-driving delivery trucks have the potential to massively lower the last-mile delivery expenses and remake the economics of freight out in the coming decade. These technologies will be costly now to early adopters, but ultimately, will allow the delivery of products and services to the business at lower costs when the infrastructure is invested in.
Freight out decisions are being made based on sustainability issues other than cost optimization. Carbon-neutral shipping or electric delivery, and optimal route minimizing environmental impact are emerging as a customer expectation and not a nice-to-have differentiator. Proactive companies are now considering carbon footprint in addition to cost in decision-making regarding freight out in the realization that green credentials are becoming critical in purchase choices.
Other new freight out models, including those developed by Uber Freight and other platforms, are introducing flexibility to the crowd-sourced delivery models and may reduce the cost of local delivery. Such gig-economy business models of freight have the potential to complement the existing carriers, particularly when it comes to same-day or predetermined delivery slots, which fetch a higher price.
Lastly, the blockchain technology is starting to create a level of transparency in freight out costs and performance hitherto not experienced before. Smart contracts automatically send funds when the delivery milestones are confirmed and that administrative overhead is lowered and immutable freight costs records are accessible to the accountant and auditor.
Conclusion: Take Control of Your Freight Out Costs
Freight out is not any shipping cost, it is a very important cost factor that affects directly your profitability, competitive positioning and accuracy of financial reporting. The key to effective cost management lies in understanding what freight out is, the difference between freight out and freight in and how to ensure that you record it correctly in your accounting system. And regardless of whether you are operating an e-commerce store and covering shipping fees, a B2B enterprise and partnering with freight providers to negotiate price breaks, or expanding a business and exploring ways to strategically help customers with costs, the steps listed below, such as carrier negotiation and packaging optimization, provide tangible avenues towards reducing the costs of freight out and keeping customers happy. As the real world example shows, even small gains in freight out management can be translated to significant margin gains. It is high time to revisit your existing freight accounting methods, examine your shipping information on optimization possibilities and trial at least one cost-cutting strategy. Freight out management is not merely a cost reduction exercise but rather financial visibility that enables better pricing, better profitability analysis and ultimately, a healthier bottom line.