Freight-Out

Freight-Out (also known as a 'delivery expense') is the transportation cost a company pays to ship its finished goods to a customer. Think of it as the final journey for a product, from the seller’s warehouse to the buyer's doorstep. This cost appears on the income statement as part of the selling, general, and administrative expense (SG&A). It's a crucial operating expense incurred in the process of making a sale. For a value investing practitioner, it’s vital not to confuse freight-out with its cousin, freight-in. Freight-in is the cost of getting raw materials or inventory to the company's factory or warehouse. While freight-out is a selling expense, freight-in is considered a direct cost of getting the product ready for sale, so it's included in the cost of goods sold (COGS). This distinction is more than just accounting trivia; it directly impacts a company's key profitability metrics and offers clues about its operational structure.

This seemingly mundane expense is a treasure trove of information. How a company manages its shipping costs can reveal a great deal about its business model, efficiency, and competitive standing. It’s a key variable in the age of e-commerce, where “free shipping” is often a customer expectation.

A company’s policy on shipping costs speaks volumes about its pricing power.

• Absorbing the Cost: Companies that offer “free shipping” are absorbing the freight-out cost. They can only do this sustainably if they have healthy profit margins or a strong competitive advantage that makes customers willing to pay a premium for the product itself.
• Passing the Cost: Companies that charge customers separately for shipping may have thinner margins or operate in a more competitive space where they can't afford to absorb the cost.

Tracking the freight-out expense as a percentage of sales over time is a powerful analytical tool. If this percentage is climbing, it could be a red flag. It might mean the company is losing its ability to pass on rising fuel and logistics costs, or that its own delivery network is becoming less efficient. Conversely, a company that consistently lowers this percentage, like Amazon did by building its own logistics empire, is demonstrating masterful operational control.

The accounting treatment of freight-out directly influences how we interpret a company's profitability.

• Impact on Gross Margin: Because freight-out is not in COGS, it does not affect the gross margin (Gross Profit / Revenue). Gross margin tells you how profitable the product itself is, before other operating costs.
• Impact on Operating Margin: Because freight-out is in SG&A, it directly reduces the operating margin (Operating Profit / Revenue). The operating margin reflects the profitability of the entire business operation.

This distinction is critical when comparing companies. If Competitor A includes shipping costs in its COGS while Competitor B lists them under SG&A, a direct comparison of their gross margins would be misleading. Competitor A would look artificially less profitable on a gross basis. Always dig into the notes of the financial statements to understand how a company classifies its shipping costs.

Let's imagine “Gadgets Galore Inc.” sells a popular smartwatch. Here’s a simplified breakdown of a single sale:

• Sale Price: $300
• Cost to Manufacture (COGS): $120 (This includes materials, factory labor, and freight-in costs for parts).
• Cost to Ship to Customer (Freight-Out): $15

Here's how it would look on the income statement:

1. Revenue: $300
2. Cost of Goods Sold (COGS): $120
3. Gross Profit: $180 ($300 - $120)
4. Gross Margin: 60% ($180 / $300)

Now, let's add in the other operating expenses. Let's say SG&A includes $40 for marketing and salaries, plus the $15 for shipping.

1. SG&A Expense: $55 ($40 + $15 freight-out)
2. Operating Profit: $125 ($180 Gross Profit - $55 SG&A)
3. Operating Margin: 41.7% ($125 / $300)

As you can see, freight-out bypasses the gross profit calculation and directly reduces the operating profit.

Freight-out is far more than just a shipping fee. For the savvy investor, it's a diagnostic tool. A rising freight-out cost relative to sales can signal eroding margins and weakening competitive strength. A well-managed freight-out cost can be a sign of a wide economic moat built on logistical excellence. The Bottom Line: Don't gloss over this line item. Always compare it to revenue over time, understand how the company classifies it (COGS or SG&A), and never, ever confuse it with freight-in. This small detail can make a big difference in understanding a company's true profitability and operational prowess.