Freight out costs: Meaning, Criticisms & Real-World Uses

What Are Freight Out Costs?

Freight out costs are the expenses incurred by a seller to transport goods from their location to the buyer's designated delivery point. These costs are a crucial component of a company's financial reporting, specifically within the realm of accounting and supply chain management. Unlike expenses associated with bringing inventory into a company, freight out costs relate to the outbound movement of goods, often impacting a business's overall operating expenses and ultimately its profitability. Companies must carefully manage these costs as they directly influence a product's final price and the efficiency of the entire supply chain.

History and Origin

The concept of freight costs is as old as trade itself, evolving from ancient maritime routes and overland caravans to modern global logistics networks. Historically, the party responsible for transportation costs was determined by the agreed-upon trade terms, such as "Free On Board" (FOB) shipping point or FOB destination. As commerce expanded and supply chains became more complex, the classification and management of these costs became increasingly sophisticated.

The dramatic decline in real maritime freight rates, particularly for dry bulk cargo, is a significant historical trend. Research indicates a cumulative decline of 79% between 1850 and 2020, with periods of both steep falls (1850-1910 and 1950-2020) and reversals (1910-1950). This long-term reduction in transportation costs has been driven by productivity growth in the shipping sector, including changes in ship cargo capacities and improved port turnaround times²³, ²⁴. The deregulation of the U.S. trucking industry in the early 1980s, for instance, further influenced freight pricing by fostering competition and introducing elements like fuel surcharges to account for volatile fuel prices²².

Key Takeaways

Freight out costs represent the expense of delivering goods from a seller to a buyer.
They are typically classified as selling expenses or part of the cost of goods sold on a company's income statement.
Accurate accounting for freight out costs is essential for determining gross profit and overall profitability.
Fluctuations in freight rates can significantly impact a company's financial performance and consumer prices.
Effective supply chain management strategies are critical for controlling and optimizing freight out costs.

Formula and Calculation

Freight out costs do not typically follow a single, universal formula in the same way a financial ratio might. Instead, they are the sum of various charges levied by carriers and logistics providers for the transportation service. The calculation involves identifying all components of the shipping expense for a given outbound shipment or period.

Common components that contribute to freight out costs include:

Base Freight Rate: The fundamental charge for moving goods from origin to destination.
Fuel Surcharges: Additional fees to cover fluctuating fuel prices.
Accessorial Charges: Costs for supplementary services, such as liftgate services, detention fees, re-delivery charges, or customs duties for international shipments.
Insurance: Premiums for cargo insurance.

The total freight out cost for a period is generally calculated as the sum of these charges for all goods shipped:

\text{Total Freight Out Costs} = \sum (\text{Base Rate} + \text{Fuel Surcharge} + \text{Accessorial Charges} + \text{Insurance})

Businesses use transportation management systems and freight auditing processes to track and verify these individual charges to ensure accurate expense recognition.

Interpreting Freight Out Costs

Interpreting freight out costs involves understanding their impact on a company's financial statements and overall operational efficiency. When analyzing a company's financial performance, high freight out costs relative to revenue or gross sales can indicate several issues: inefficient logistics, unfavorable shipping contracts, rising fuel prices, or a need to re-evaluate pricing strategies.

Conversely, stable or declining freight out costs, especially as sales volume increases, might suggest effective supply chain management and strong cost control. These costs directly affect a company's gross profit margin and overall profitability. For instance, an increase of just 8% in transport costs could reduce profit margins by the same degree²¹. Therefore, tracking freight out costs as a percentage of sales or against industry benchmarks provides valuable insight into a company's operational health and its ability to deliver products to customers efficiently. Companies often look to optimize their working capital by managing these outflowing expenses effectively.

Hypothetical Example

Consider "GadgetCo," a company that manufactures consumer electronics and ships them directly to retail stores across the country. In a given month, GadgetCo sells 1,000 units of its new "UltraWidget" for $500 each, totaling $500,000 in revenue.

To deliver these 1,000 units, GadgetCo uses a third-party logistics provider. The total cost incurred for all outbound shipments for the month, which includes the base freight charges, fuel surcharges, and a few accessorial fees for difficult deliveries, amounts to $25,000.

In this scenario:

Sales Revenue: $500,000
Freight Out Costs: $25,000

When preparing its income statement, GadgetCo would record the $25,000 as a selling expense or as part of its cost of goods sold, depending on its accounting policy and the nature of the shipping terms. If GadgetCo shipped FOB destination, these freight out costs would be an expense borne by GadgetCo. This expense directly reduces GadgetCo's gross profit, illustrating the direct financial impact of these costs.

Practical Applications

Freight out costs are a critical consideration across various business functions, particularly in supply chain and financial analysis.

Financial Reporting and Analysis: Companies report freight out costs on their financial statements, typically as part of selling, general, and administrative (SG&A) expenses or as a component of the cost of goods sold (COGS). The specific classification often depends on the company's accounting policies and the nature of the transaction. Under U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), if shipping and handling are considered fulfillment costs after the customer obtains control of a good, they are expensed. If they are deemed a separate performance obligation, then any revenue from them is recognized, and the related costs are matched as shipping expense¹⁸, ¹⁹, ²⁰. This classification directly impacts a company's gross profit and operating income. Analysts often scrutinize these costs to gauge operational efficiency and cost management.
Pricing Strategy: Businesses must factor freight out costs into their product pricing to ensure adequate profit margins. When freight rates surge, companies may need to adjust their pricing or absorb the increased costs, which can impact their competitiveness¹⁷.
Supply Chain Optimization: Effective supply chain management focuses on minimizing freight out costs through route optimization, carrier negotiation, shipment consolidation, and leveraging technology. This includes choosing the most cost-effective modes of transport (e.g., road, rail, air, sea) and negotiating favorable freight rates¹⁶. Global container indexes, such as the Drewry World Container Index (WCI) or the Freightos Baltic Index (FBX), provide benchmarks for international ocean freight rates, helping businesses understand market dynamics and negotiate more effectively¹³, ¹⁴, ¹⁵.
Inventory Management: Efficient inventory strategies, such as increasing minimum order quantities or optimizing load sizes, can help reduce the frequency and cost of outbound shipments¹².

Limitations and Criticisms

Despite their straightforward definition, freight out costs present several accounting and operational complexities. One significant area of debate revolves around their classification on the income statement. While commonly treated as a selling expense, some arguments suggest they are integral to getting a product ready for sale and thus should be included in the cost of goods sold. Under U.S. GAAP, if shipping charges are separately stated to the customer, they must be reported as revenue, and the associated cost as shipping expense, prohibiting netting against revenue¹¹. However, entities can elect to account for shipping and handling activities performed after customer control as a fulfillment cost¹⁰. This accounting policy election influences how revenue is recognized and how expenses are presented, potentially affecting financial ratios and the comparability of financial statements across different companies.

Another limitation stems from the volatility of freight rates themselves. Factors like fuel prices, carrier capacity, global demand, port congestion, and geopolitical events can cause significant and unpredictable fluctuations⁷, ⁸, ⁹. This variability makes accurate forecasting and budgeting challenging for companies, potentially leading to increased transportation costs and decreased profit margins if not managed proactively⁶. Passing these increased costs onto consumers can also lead to higher consumer prices, creating broader economic impacts⁵. Furthermore, external links related to critiques or academic discussions often highlight how misclassified expenses or untimely recognition of transport costs can distort financial analysis and budgetary control⁴.

Freight Out Costs vs. Freight In Costs

Freight out costs and freight in costs both relate to transportation expenses but differ fundamentally in their purpose and accounting treatment. Understanding this distinction is crucial for accurate financial reporting and inventory valuation.

Feature	Freight Out Costs	Freight In Costs
Definition	Expenses incurred by the seller to deliver goods to the buyer.	Expenses incurred by the buyer to bring purchased goods to their location.
Purpose	Part of the selling and distribution process.	Part of acquiring inventory and making it ready for sale.
Classification	Typically a selling expense (operating expense) or part of Cost of Goods Sold.², ³	Added to the cost of inventory, then expensed as Cost of Goods Sold when the inventory is sold.¹
Impact on Books	Reduces gross profit or operating income directly.	Increases the cost basis of inventory on the balance sheet until goods are sold.

While freight out costs are an expense associated with the sale and delivery of goods, freight in costs are capitalized into the cost of inventory. This means freight in costs are initially recorded as an asset (part of the inventory value) and only become an expense (Cost of Goods Sold) when the inventory is sold. Freight out costs, on the other hand, are typically expensed as they are incurred. This difference in treatment highlights their distinct roles within a company's operational cycle and financial structure.

FAQs

Q1: Are freight out costs considered part of the cost of goods sold (COGS)?

A1: The accounting treatment of freight out costs can vary. While some companies include them in the Cost of Goods Sold, they are more commonly classified as a selling or Operating Expenses on the Income Statement. This classification often depends on whether the company views shipping as a fulfillment activity or a separate service offered to the customer, especially under modern Revenue Recognition standards like ASC 606.

Q2: How do freight out costs impact a company's profitability?

A2: Freight out costs directly reduce a company's gross profit and overall Profitability. Since they are expenses incurred to deliver products, higher freight out costs mean less revenue is available to cover other operating expenses and contribute to net income. Efficient management of these costs is crucial for maintaining healthy profit margins.

Q3: What factors can cause freight out costs to fluctuate?

A3: Several factors can cause fluctuations in freight out costs, including fuel prices, carrier capacity and demand, geographical distance, the weight and dimensions of the goods, and the mode of transportation (e.g., air, sea, truck, rail). Global events, economic conditions, and disruptions in the Logistics network can also significantly impact these costs.

Q4: How can a business reduce its freight out costs?

A4: Businesses can implement several strategies to reduce freight out costs. These include negotiating better rates with carriers, consolidating shipments to achieve volume discounts, optimizing shipping routes, using different modes of transport, and improving Inventory management to reduce expedited shipping needs. Leveraging technology for Supply Chain Management can also help identify efficiencies.

Q5: Do customers pay for freight out costs?

A5: While freight out costs are incurred by the seller, they are often indirectly passed on to the customer either as a separately stated shipping charge or embedded within the product's selling price. The decision of whether to charge customers directly or absorb these costs impacts the company's pricing strategy and competitiveness.