What Is Distribution Cost?
Distribution cost is the total of all those expenses that the producer of a product incurs to make the delivery of the product from its location to the end customer’s location possible. Thus, for a manufacturer, it includes all those expenses incurred to make possible the product delivery from its production site to the customer’s location, whether retailer, wholesaler or the final customer.
It can also be referred to as the logistics cost that the distributor incurs. They are related to various activities involved in the transfer of goods, like inventory management, packing, warehousing, transportation, etc., which are all a part of the order fulfillment process.
Distribution Cost Explained
Distribution cost is the cost incurred by the company or the distributor in managing and transferring the goods and services from the company location to the location of the customer and thus successfully fulfilling the order.
An item is manufactured at the production site, say factory, and is then kept at the warehouse for distribution to potential customers afterward. To deliver the product from the warehouse to the customer’s location, the producer may incur several expenses, including but not limited to shipping costs. Thus, selling and distribution cost includes all those expenses incurred for making the delivery to the customer. The same is usually recovered from the customer by adding the same in the per-unit price of the product.
It is crucial to the business because it ensures competitiveness and profitability. The customers will remain satisfied and continue with their orders only when they get the delivery of the goods on time and in the exact condition in which they want.
Thus every company strive to become the best in the market regarding their distribution network and supply chain management because merely selling the products and services will not bring revenue to the business, but good distribution cost analysis, efficient and timely delivery is equally important.
How To Calculate?
The calculation of the selling and distribution cost involves the summation of all the direct and indirect costs that the company will bear in the distribution process. The method and steps may vary depending on the type of company and the accounting practices followed over there. The steps are given below:
- Cost identification – The company has to identify the cost categories that are a part of the distribution process which may be warehousing, transportation, packaging, reverse logistics cost, etc.
- Gather data – Data has to be collected in each cost category which may be invoice, expense reports or any other documents. They may be directly or indirectly related to the delivery process.
- Indirect cost allocation – The total distribution cost need to be allocated in a systematic basis using various cost drivers. The delivery department should understand and keep track of the sales, number of orders, area of the storage occupied for the sales, etc. This will make the allocation process easy.
- Calculate cost – Next is the summation of all the cost incurred in the delivery process of that order.
- Analysis – The final step is analyse and interpret the distribution cost structure. This will help in pointing out the inefficiencies, resource wastage and potential areas where cost can be reduced.
However the level and type of details used and methods of calculation of distribution cost in income statement will vary depending on the type of organization and data availability.
Examples
Given below are some important examples of distribution cost that the entity normally incurs after receiving the order for sale from the customers.
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For eg:
Source: Distribution Cost (wallstreetmojo.com)
Below are some crucial examples of distribution costs that the entity typically incurs after receiving the customer order for sale.
#1 – Freight Cost
Freight Cost refers to the transportation expenses incurred for transferring the product from the manufacturer to the customer’s location. It can either be incurred by the customer itself or maybe first incurred by the manufacturer and then recovered from the customer by including the same in the product’s price.
#2 – Storage Cost
The products, once manufactured, are kept for storage at the warehouse until they are sold to the customer. Therefore, a manufacturer incurs expenses concerning storing the products in the warehouse, such as warehouse rent, which forms part of the distribution cost.
#3 – Product Handling Cost
It includes costs related to maintaining the products kept at the warehouse. It will consist of all those expenses incurred to maintain the quality of the product and keep them in good condition.
#4 – Direct Selling Expenses
A manufacturer may incur expenses directly by selling the product or attracting customers to buy the products. Examples of such expenses include the salary of marketing personnel (only involved in targeting customer sales), training costs, office expenses necessary for sales, etc.
#5 – Advertisement Expenses
Advertisement expenses also form part of the distribution costs. Such cost helps a manufacturer develop its presence in new areas. Examples may include amounts spent on advertisements done by hoardings, newspapers, media channels, and so on.
#6 – Managerial Personnel Cost
Apart from these total distribution cost, this may also include other expensesExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities.read more such as the cost of managerial personnel involved in warehouse management, packaging cost, and so on.
Accounting For Distribution Cost
In the income statement, this cost is recorded under operating expense section, which may vary depending on the accounting practices followed by the business. They are all indirect costs and fall in the selling and distribution expenses category. This reduces the net profit of the company.
The distribution cost in income statement is recorded when the goods reach the customer. The journal entry for the same is as follows:
Distribution Cost A/c Debit
To accounts payable A/c.
This cost is not shown in the balance sheet, cash flow statement or statement of changes in equity.
How To Reduce?
There are various was to reduce cost of goods and services distribution. Low distribution cost in income statement will positively impact the profits of the company in a huge way. Some of them are given below:
- It is necessary to have an efficient supply chain that is dedicated to enhancing the distribution process by streamlining the communication system. They should do distribution cost analysis to know the best transportation routes, be able to collaborate with the customer and the supplier as well as plan and forecast the problems and solutions.
- The freight rates should be reasonable.
- The space utilization for storing the materials to be transported should not be too costly.
- Orders to different customers within the same location can be consolidated to reduce transportation expense and maximise efficiency.
- Technology should be upgraded to provide services like quick location tracking, routing and scheduling pick and drop, real time tracking of delivery, etc.
- Customers should be divided as per the service and profitability levels, frequency of orders. Supplies should collabotae with customers to meet requirements on time.
- There should be a continuous improvement in the system to control cost and reduce wastage.
Benefits
- When a manufacturer develops an efficient distribution system, it can obtain a competitive edge over others. Such a manufacturer will be able to fulfill its delivery commitment to its customers in time and much quicker.
- The quality of the products is improved by incurring costs such as packaging costs, quality control costs, etc.
- The customers can benefit from better-quality products, and the manufacturer enjoys goodwillThe Manufacturer Enjoys GoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more.
- Customers’ trust is increased when distribution costs, such as transportation costs, are directly met by the manufacturer.
Importance
The costs incurred over a manufacturer’s distribution network help it in its customer building and customer management. It is so because the costs will keep the products look presentable and thereby enhance sales. Also, there are several distribution networks one may follow, which will help in the quicker and smooth delivery of the products. If a company engages a good distribution network, it also helps it to target specific audiences and mass audiences.
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