As an enterprise operating in a B2B environment, how do you manage and calculate restocking fees? For instance, are you aware that accepting returns is akin to increasing your inventory carrying costs? After all, you are accepting a product return and will therefore have an increase in your finished good count. As such, it’s important to understand that your restocking fees must cover three essential costs; the costs of carrying product before it was sold, the costs of freight (if included as a service), and a cost represented by a percentage of your overhead. Why overhead? Simply put, your overhead includes all those support costs that go along with making sales, inventory and operations work.
The Role of Overhead in B2B Restocking Fees
Every company understands that its inventory costs money, but not all are aware of how those costs are determined or what role their overhead plays. First, there are costs to carrying inventory. These include the costs of damage, pilferage (theft), freight, warehouse overtime, obsolescence and other warehouse management costs. Second, there are ancillary support costs that pertain to operations; customer service, sales, marketing, procurement and accounting all play a direct or indirect role in managing a company’s inventory counts. Third, there is the company’s cost of capital, which includes the costs of borrowing money to finance inventory.
While not all of these pertain to a company’s overhead, there are still portions of managing inventory that come from those aforementioned ancillary support costs of operations. In essence, these support roles help to market, package, store, sell and invoice inventory. Therefore, you must recoup some of those support costs within your fees for returned product.
Calculating B2B Restocking Fees
Our approach to determining restocking fees will focus on our three cost drivers; 1) inventory carrying costs, 2) costs of freight (as a service) and 3) a portion of overhead to cover our support costs.
1. Inventory Carrying Costs: Most companies apply 3% to their carrying costs of inventory. These costs are summarized by obsolescence, damage, financing, freight, warehouse management, pilferage and overtime. For a complete rundown of these costs, please refer to: Sample Inventory Costing Excel Sheet: Graph & Pie-Chart of Expenditures. The most important portion of our calculation is to cover the time your company holds inventory before it’s sold. In this case, we’re referring to your inventory turnover rate.
We’ll apply this 3% monthly carrying cost directly to the product’s costs of goods sold (COGS) and determine total carrying costs by accounting for the number of days the inventory was held before it was sold. This will cover our original carrying costs of inventory. However, we’ll double this amount in order to cover the costs carrying inventory on the returned product.
(Initial Carrying Costs) + (New Carrying Costs)
2. Costs of Freight: There are always costs to get products into your warehouse. These costs should be included in your product’s COGS, so we’ll not include it in our restocking fee. However, if your company includes freight as a service on delivery, then you are well within your right to recoup this cost.
It is your decision whether to include a surcharge on this freight cost. You provided a delivered price to your customer and now that they want to return good product, you should recoup that original cost. Now, if you cover the freight cost on returns, then you must recoup this as well.
(Per-Unit Freight Cost or Total Freight Cost)
3. Overhead: In our calculation, we’ll use your company’s overhead percentage in order to cover your operational support costs. Simply put, your overhead percentage is calculated by taking your indirect expenses and dividing them by your direct expenses. Your indirect expenses include those previously mentioned support costs. These are costs that aren’t included in the production of a finished good, but are costs that your company must still cover. Your direct expenses are those that are directly linked to manufacturing a given product.
In this case, they would include the costs of material and labor. Most importantly, direct expenses fluctuate with the volumes sold or manufactured. In this step, we are covering those costs that helped you manage and sell inventory. To read more about calculating overhead, please refer to: Calculating Overhead Rate & Percentage for Small Businesses.
[(Carrying Cost} * Company Overhead Percentage)]
The B2B Restocking Fee Calculation
Fee: {(Initial Carrying Costs) + (New Carrying Costs) + (Per-Unit or Total Freight Cost) + [(Carrying Cost * Company Overhead Percentage)]}
An Example of a Restocking Fee
Let’s assume your company had a product whose COGS totaled $1,000.00. If you held that product for one month, your carrying costs would be $30.00 (3% * $1,000.00). However, in our example, you’ve held this product in inventory for 15 days. It’s a product line that has a high inventory turnover rate. Therefore, the holding costs are only $15.00. However, you must also cover additional carrying costs upon receiving the returned product because we assume it will take you another 15 days to sell it again. You incurred a $30.00 shipping cost to deliver you product and your current overhead percentage is 50%.
- Fee: {(Initial Carrying Costs) + (New Carrying Costs) + (Per-Unit or Total Freight Cost) + [(Carrying Cost) * Company Overhead Percentage)]}
- Fee: {($15.00) + ($15.00) + ($30.00) + [($15.00) * 50%)]}
- Fee: {($15.00) + ($15.00) + ($30.00) + [($7.50)]}
- Restocking Fee: $67.50
Dangers of Charging a Flat Fee
This approach goes against those enterprises that decide to charge their B2B clients a flat restocking fee of anywhere from 15% to 20%. Unfortunately, charging a flat fee across all product lines penalizes all customers, regardless of the product’s inventory turnover rate. In essence, it penalizes those customers who purchase high inventory turnover rate items. What you want to do is charge a fee that represents your true costs of carrying that inventory, your costs of freight as a service and your support costs to sell that product. If you have products that sell quickly, then you shouldn’t be charging as much of a return fee as those products that take longer to sell.
In our example, our $67.50 is only a 6.75% based on COGS of $1,000.00. Now, why is our fee lower and is it enough? First, it’s important to understand that your company must charge a fee reflective of your inventory carrying costs. Since we’ve based it on the number of days you hold inventory, we’ve allowed you to charge less for products with high inventory turnover rates (sell faster) versus those products that have low inventory turnover rates (take longer to sell). Second, we’ve accounted for two carrying costs – one is the original cost of holding inventory before making a sale, while the other is the new cost of holding that inventory once it's returned. In essence, our carrying costs are based on 15 days, so it’s natural to assume that we’ll hold that inventory again for 15 days before selling the product again. Third, we’ve accounted for your company’s operations and support costs, ones that play a vital role in managing your inventory and ones that help support your sales.
1. Fees Should Represent Inventory Turnover Rates: You should charge a lower fee for product returns that have high turnover rates (sell quickly) as opposed to a higher fee for products with low turnover rates (take longer to sell)
2. Fees Should Cover Inventory Carrying Costs: his approach captures both carrying costs - the initial costs and the costs of accepting a product return.
3. Fees Should Cover Support Costs: We've accounted for all support costs, ones that help your company manage, market, sell, package and ship product to your customer. These are support costs that your company should cover within its fees for returned product.
Take the time to explain your B2B restocking fees to your customer base. Our approach has captured all relevant costs, but if you feel they are not enough, or are not reflective of your costs to accept product returns, then by all means charge what you feel is necessary. However, make sure you charge a lower amount for products that sell faster, versus those that take longer to sell. You want customers that help your enterprise increase its turnover rates. You shouldn’t charge them the same fee for products that you hold for longer periods, ones that have much higher carrying costs. Finally, it’s important you define your product categories based on your inventory turnover rates. Segregate your inventory into products based on how long you hold them before making sales. This will help clarify how you charge for taking back good product.
The above video provides some insight into determining overhead rates and percentages. It is shown towards the end of the video and is from the post: Calculating Overhead Rate & Percentage for Small Businesses
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