Business operations require resources – capital and personnel. The costs arising from their use can be divided into two categories: direct and indirect costs. Direct costs include, for example, raw materials, finished components purchased from other companies, or goods acquired for resale. The magnitude of these costs can be predicted and monitored based on production or sales volumes.
In the order–delivery process, the costs of purchasing, sales activities, customer service, and logistical operations are indirect overhead costs. These also include the costs of facilities, machinery and equipment, IT systems, marketing activities, travel, and capital tied up. A significant portion of a company’s indirect costs is connected to events in the order–delivery process and the amount of inventory. Monitoring these costs by product or customer is quite feasible, yet many companies do not do this at all.
Overhead Costs Should Also Be Allocated
Traditional cost accounting is well-suited for tracking the total costs of purchasing, production, and marketing departments and their budget deviations. However, traditional cost accounting cannot accurately determine the impact of these functions on the profitability of specific products or customers. The total overhead costs are known, but it has not been easy to allocate them correctly to customers or products sold based on their cause. Often, these are allocated based on a general overhead percentage.
If the sales value in a certain product group is small, then small overhead costs are allocated to it based on the percentage, regardless of how much that product group actually incurs logistical or sales-related expenses.
Overhead costs typically account for 20–30% of revenue. The problem in their allocation is that different products and customers incur overhead costs in very different ways: for some products and customers, they are several times higher, and for others, almost non-existent. Incorrectly allocating overhead makes it difficult to track the true profitability of customers and products. When overhead costs exceed 15% of total costs, it causes inaccuracies in traditional cost accounting.
Most overhead costs stem from sales, customer service, and the procurement of raw materials, supplies, and merchandise. We call this group of expenses collectively transaction costs.
Each stage of the order–delivery chain requires its own necessary workload. When all business expenses are divided by the number of transactions, transaction costs can easily become excessively high, especially for products with a lower level of processing or a low unit price.
The Order–Delivery Process in Companies
Part of the transaction costs involves management expenses. These are typical office tasks—purchasing, selling, and monitoring. Some costs arise from moving (transporting) goods from one place to another and storing them at various stages of the process.
In industry and commerce, the order–delivery process can be divided into three stages: incoming process, storage, and outgoing process. The terms inbound and outbound are often used to describe the incoming and outgoing processes.
The order–delivery process spans across company responsibilities. Sales and purchasing transactions, along with storage, create significant workloads = transaction costs.
The incoming process consists of procurement, transportation of purchased products, handling incoming goods and purchase invoices at the first storage point, and payment of purchase invoices. The outgoing process similarly includes tasks arising from customer service, shipments, transportation, and product invoicing. The outgoing process ends with the delivery of the product to the customer or the recording of the payment transaction.
Between the incoming and outgoing processes are storage facilities that require resources such as capital, storage space, and equipment. Storage costs are also incurred from shrinkage and product expiration. The warehouse staff, on the other hand, are part of the incoming or outgoing process.
Examining the costs of the order–delivery chain through the division of incoming process – storage – outgoing process illustrates how much work needs to be done before products are ready for sale. This work must be taken into account in the final product’s pricing.
Carrying Out a Cost Assessment
Cost assessment and allocation resemble activity-based costing. The assessment begins by breaking down processes into activities and investigating what resources they use and how much costs are incurred. Resources refer to personnel, facilities, machinery and equipment, IT systems, and capital.
When the entire workforce is divided and allocated to the various functions of the order–delivery process, their wage costs are simultaneously known. It is important that the entire workforce of the company or unit is included in the assessment. Otherwise, the results are unreliable.
Direct Work and Other Work
The workload related to the direct implementation of purchasing and sales transactions should first be separated from the personnel performing procurement and customer service.
Actions that generate direct costs include:
- Advising customers on orders and receiving customer orders
- Sending purchase orders to suppliers, receiving incoming goods, unpacking batches, inspecting, moving them forward, and processing purchase invoices
- Picking goods from the warehouse, packing, preparing for shipment, and invoicing
- Transporting goods to the company, within the company, and to customers
- Monitoring deliveries and handling complaints
It is always worth asking: does the direct work add value for the customer, or is it just an expense caused by the current operational method? Can the method be changed? Would new equipment or IT systems speed up the execution of the task? It is likely that direct work does not add value, which is why knowing the costs of direct work is important.
Direct work is one part of the personnel costs in the order–delivery process. The other part of the staff involved in transactions performs “indirect” work, which is hard to categorize under a unified heading. In the outgoing process, some staff work on marketing, sales, and operations planning. In procurement, direct replenishment orders do not consume many resources, but time is spent searching for, monitoring, and maintaining supplier relationships.
Storage Costs
Warehouse staff are part of either the incoming or outgoing process, and warehouse personnel costs are accounted for there. Storage costs in cost assessments refer only to the costs of space, capital tied up, and possible shrinkage.
Storage costs include:
- Inventory (working capital) interest costs (inventory costs)
- Costs of space and equipment required for storage (warehousing costs or storage costs)
- Costs of shrinkage, obsolescence, and non-performing inventory (obsolescent costs).
Storing goods requires space, and using that space generates capital or rental costs. Warehouse rent can be based on weight, square meters, cubic meters, or pallet positions. The most common unit is the pallet position. The costs of your own shelves, containers, boxes, pallets, and other equipment are also considered space costs. Furthermore, the costs of maintaining cleanliness, lighting, heating, cooling, insurance, and similar actions must be calculated. Space costs differ between outdoor and indoor warehouses, as well as between pallet and small goods warehouses. These costs must be assessed separately.
Factory Hall or Retail Store as Partially Storage Space
For separate storage spaces, calculating the cost of storage is easy. However, this is not enough. Additionally, the costs of production and sales areas where goods are stored must also be considered. Often, even half of the floor space in these areas is occupied by goods. Many companies do not have separate storage spaces at all. The warehouses are in the factory or store. The estimate is based on the floor space covered by goods and the necessary aisle space.
Space costs do not adjust as flexibly as capital costs when inventory decreases. However, over a longer period, they too are variable costs. As revenue grows, no additional storage space may be needed if the inventory turnover rate has improved. Fully freed-up storage spaces can be used for other business activities or rented out or sold off.
Transportation Costs
If the company has its own transport fleet, it is accounted for along with other machinery and equipment. The transport personnel are part of either the incoming or outgoing process. The costs of purchased transportation services are tracked based on actual freight charges. Transportation service providers must be required to itemize costs per shipment. This allows for monitoring by product, supplier, or customer. It is not sufficient for transportation costs to be recorded as a lump sum in a single account.
Purchased Services
In some companies, order–delivery chain tasks are performed by the company’s own staff, while in others, some tasks are outsourced as services. Common outsourced logistics services include transportation, freight forwarding, or third-party logistics and warehousing services. The service provider can also be another unit within the same company or group, for example, if warehousing and financial administration are centralized. Using services makes cost assessment easier because the service provider bills for the work done.
Collaboration and Avoiding Costs
Every phase of the chain incurs its own cost, but there are many ways to influence the size of these costs. For example, could the previous phase be done in such a way that it doesn’t need to be checked or redone? Or could the order from the customer be in a format that doesn’t require further processing? When an action is done once in the chain, it should no longer be repeated or checked. When all costs are known by activity, it creates the conditions for discussions between business partners about collaboration and improving mutual competitiveness.
(Original text: Jouni Sakki. Edited by: Blomqvist / Koikkalainen)