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Putting Freight Costs in their Place

Written by Iqubal Pannu, Senior Solutions Consultant, AEB (International) Ltd In todays globalised world, many companies are active in different countr...

Freddie Pierce
|Dec 20|magazine13 min read

Written by Iqubal Pannu, Senior Solutions Consultant, AEB (International) Ltd

In today’s globalised world, many companies are active in different countries and across continents with comprehensive procurement, distribution and fulfilment networks and working with a variety of logistics service providers. Yet few of them have implemented an efficient logistics controlling process that tracks the exact cost allocation of freight expenses. What costs were incurred for transfers of products between locations? And what were the specific costs per product group or location?

Traditional accounting methods and spreadsheets are insufficient for breaking down logistics costs to the product or item level. It seems the formula most commonly used is (Pi x guesstimate)2 = freight costs for product A. The result is an imprecise allocation of freight costs, the impact of which is widely underestimated. For example, if production and logistics costs are used to set product sales prices, inaccurate freight cost allocation can lead to distortions: If prices are set too high, it can lower demand; if prices are set too low, it can squeeze the margin.

So what options exist for allocating freight costs precisely to their original cost drivers – for making freight cost reallocation more exact? How can freight and logistics costs be allocated to cost centres and accounts in a way that reflects their true cost drivers and also makes this information available for further analysis?

The first step is to define cost centres and accounts that freight costs are to be allocated to. The next step is to define the reallocation model - the reallocation key used to break down the freight costs, e.g. by weight, volume or value of the goods. How exactly the reallocation takes place depends on the purpose for which the information is gathered. Knowing how much is spent on freight and logistics is a precondition for making decisions on a whole range of issues, from basic strategy, to products, to internal logistics processes. Freight cost reallocation can serve the following objectives:

  • Market price calculation
  • Success evaluation
  • Landed costs determination
  • Make-or-buy decisions
  • Accrual-based cost allocation
  • Cash flow management
  • Comparison and evaluation of logistics performance of departments and locations

Once the actual objective of freight cost reallocation has been confirmed, the structures best suited to achieve these goals need to be determined. This is usually the job of the department that needs the cost reallocation information – typically controlling or financial accounting. Not every company requires a detailed reallocation down to the article level, for example. The objective is always to find the optimal balance between the expense of reallocation and the benefit it will bring to a particular business.

Benefits of automated freight cost reallocation

The key benefits of automated freight cost reallocation are threefold. First of all, there is no room for interpretation when it comes to cost centres, such as separate departments or locations. Costs are allocated uniformly based on defined criteria, overall logistics controlling becomes more precise, and it is easier to compare data.

Secondly, costs are reallocated quickly and without reliance on the actions of any one person. In practice, manual reallocation often leads to potentially massive delays – when the person in charge is on vacation, for example.

And thirdly, analyses follow a strict process and can be accessed by anyone, anytime. Results no longer include approximations (“pi x guesstimate”) but are based on actual freight costs.

Selecting the right software

Many companies use smart software solutions to establish automated processes, i.e. freight management software that automatically reallocates freight costs to cost centres or cost units. It’s important that companies choose a solution that allows them to create cost centres based on various criteria: material or item, package or package type, delivery note or delivery note type, client, shipment, consignee, etc. The software should also make it possible to manually edit an automatic reallocation or add additional cost centres.

But freight cost reallocation and logistics cost accounting are just one step on the road to comprehensive logistics controlling. Ultimately, freight costs should be compared against the invoiced freight charges, so that only the actual costs are paid and reallocated to the cost centres and cost units. IT-supported freight cost management helps to optimise logistics controlling and maximise efficiency – both vital prerequisites for staying competitive.

 

About the author

Iqubal Pannu is a Senior Solutions Consultant at AEB (International) Ltd, having joined the company in 2006 as a Project Manager. He has considerable consultancy and project management experience within carrier management solutions, advising companies ranging from SMEs to major multi-national corporations on how to optimise their supply chain performance within global trade and logistics. His international experience includes work in North America, Belgium, Netherlands, Germany and Spain.  Iqubal holds a BA (Hons) in Office Systems Management from the University of Hull.

AEB has released a number of white papers of freight reallocation. The white papers can be downloaded free of charge and at no obligation from www.aeb-international.co.uk/freight. Each paper in the series can be read independently of the others, though some cross-referencing is possible.