What Is Consignment Inventory? Everything You Need To Know

Introduction

Traditional methods of inventory management involve simply tracking inventory levels and placing orders to meet customer demand. However, retailers face two main challenges with this. Either they stock too much inventory, which ties up capital, or they stock too little, resulting in dissatisfied customers and lost sales. This calls for finding the right balance of inventory levels, but it’s not an easy task.

This is where consignment inventory comes in. 

Consignment inventory is a supply chain model where retailers decide when and how to sell the consigned goods, but suppliers retain the right to ownership till they are sold to customers. Since there is no actual sale happening between the two, retailers can return unsold stock to suppliers. 

In this blog, we will deep dive into everything you need to know about consignment inventory – what it is, how it works, its benefits, the concerns with cash flow, and how HighRadius can help streamline them. 

What Is Consigned Inventory: Consignment Definition Explained

Before understanding what consignment inventory entails, it is essential to delve into the consignment meaning. Consignment is an arrangement where a supplier entrusts goods to a seller but retains complete ownership of the goods. It is a time and cost optimized process of selling goods. 

The seller keeps a portion of the profit as a commission or a flat-rate fee and passes on the remaining profit and revenue to the supplier. Key stakeholders involved in the consignment process are: 

• Consignor, that is, the supplier or the manufacturer
• Consignee, that is the retailer or the seller. 

Some examples of consignment inventory are holiday related seasonal gifts, seasonal trends, decor items, art, jewelry, clothing, perishable items, equipment, antiques, and collectibles.

Example of consignment inventory

To better understand consignment inventory, let us take an example of a clothing brand that has launched a new line of summer dresses. Instead of selling directly to customers, the brand decides to sell them through local boutiques. The latter will put up the dresses on their displays and won’t buy them upfront. When a customer walks in and buys a dress from the collection, the boutique will keep aside its portion of the profit earned as commission or a flat rate fee and forward the rest to the clothing brand. Later, when the season is over, the boutique will return the unsold merchandise at no cost to the clothing brand. 

Who Uses Consignment Inventory?

Given the lower financial risk and lower inventory-associated costs, many retailers and suppliers today prefer selling on consignment. The model is commonly used by players dealing in goods with changing trends, seasonal products, launching new product lines, and organizations facing cash flow issues. Some factors that propel organizations to utilize consignment inventory are: 

• Industries that face constant fluctuations in trends

  Selling on consignment can reduce the upfront costs of purchasing and the risks of holding up stock for long periods of time only to find out they are already out of style and being replaced. Retailers, especially in the fashion industry, benefit from selling on consignment as customers, with a preference for fast fashion, keep changing their taste. 

• Retailers testing new product lines or exploring markets 

  It can be risky for organizations to launch and sell a new product without knowing how well it will perform. For organizations that want to enter a new market, experiment with a new target market, or test their new product line, then consignment inventory is the best way forward. Consignment inventory also enables retailers to save the upfront cost involved in stock holding by helping them evaluate the market response to the new product and accordingly make the required tweaks before launching it for actual consumption. 

• Businesses selling seasonal or perishable items 

  Goods that have a lower shelf life or a short-term demand at a particular point in time are riskier to stock in large quantities. Further, they often are hard to move off the floor. Consignment agreement can help manage the time-sensitive nature of products and reduce financial risk for the retailers. However, retailers would need accurate demand forecasting, else it could backfire, creating a shortage situation. 

Apart from this, selling on consignment can be greatly beneficial to those with cash flow problems. Oftentimes, businesses may not have adequate cash to purchase large quantities of products, especially the expensive ones that take a long time to sell. Consignment inventory will help them cater to their customers while saving costs by not paying the consignor upfront for the stock they hold. Customized furniture sellers, for instance, would benefit a lot from selling on consignment, as they won’t have to invest in buying those heavy goods and pile them up in their warehouses. 

The cherry on top – retailers save cash to meet their working capital requirements while maintaining a positive cash flow, reducing the financial risk. 

How Does Consignment Work?

Consignment is a 5-step process. The supplier and retailer get into a consignment agreement. Once signed, the supplier will ship the goods. The retailer then sells them to customers and returns the unsold goods. The retailer retains a portion of the profit, paying the remaining to the supplier.

Let’s understand this in detail. 

1. Preparation of consignment agreement

   The first step involved in a consignment arrangement is that the supplier and retailer get into a consignment agreement. A consignment agreement is a legal contract between the consignee and consignor that mentions the terms and conditions for payment, returns, lost goods and other details such related to cost and shipping. 

   Once the agreement is signed, the consignor will ship the goods to the consignee who will then sell them to customers and return the unsold goods. The consignment agreement can also have other information related to how the retailer should handle the goods, what will be the commissions or deposits and who would bear responsibility for damaged or lost goods. 

2. Consignment shipment

   Once both parties are on the same page and agree to the terms laid down in the consignment agreement, the supplier will prepare to move the goods from the consignment warehouse to the retailers’ store. 

   Additionally, both suppliers and retailers follow one methodology when it comes to how to track a consignment. The tracking details should include the quantity of the goods sent, complete description and the location of retailers. This can be done either manually or using inventory management software. 

3. Inventory sale by retailers

   The retailers will now list the consignment inventory and display them in their store. Once a customer walks in and purchases from them, the retailer will then record it as a normal sale. However, the profit margins for the retailers will depend on the cost of goods sold (COGS) decided prior. 

4. Supplier payment

   Retailers may choose not to pay immediately on receiving the goods. In which case, they can send a consignment invoice or settlement report to suppliers, mentioning the units sold so far, the selling price, the amounts due, commission allocated from the revenue, and so on. Solutions like automated invoicing can help streamline invoice sending across channels like emails, post, fax, etc. 

5. Return of unsold goods to suppliers

   Once the consignment period ends, the retailers can return the unsold inventory. Since the transfer of consigned goods between the parties is not an actual sale, the ownership remains with the supplier, which means retailers can send them back if they are unable to sell them. 

Let’s take an example

Suppose, an antique wholesaler specializing in pottery and vintage items wants to sell their product but doesn’t have his storefront. So, instead of investing in a new store, they decide to ask a local home decor store who agrees to display and sell their artifacts in their store. Now, here’s how consignment will work. 

• Agreement

  The wholesaler and the retail store will sign a consignment agreement mentioning the latter’s commission rate on each sale, how much the wholesaler will retain, and for the duration for which the goods will be displayed. For instance, the agreement can say that the artist would receive 70% of the sales revenue while the retail store would keep the remaining 30% of the revenue. 

• Delivery 

  Next, the wholesaler will deliver the stock from their consignment warehouse to the retail store. At this time, the boutique will not pay the wholesaler as these goods are received as a part of a consignment. However, they will carefully list and display the items for their customers in their store. 

• Sales 

  The retail store will wait for customers to turn up, explore the artist’s products, and finally buy them. When a sculpture or any other pottery item is sold, the retail store will process it as a usual sale. But instead of paying the wholesaler upfront, they will keep track of the consignment sales made on behalf of the wholesaler. 

• Payment

  At the end of the month, the retail store will tally the sales of the artist’s inventory. Suppose they sold five pieces for a total of $500. The store will keep aside $150 (30% commission on sales) and transfer the remaining $350 to the artist. 

• Restocking or consignment inventory management 

  If any pottery items remain unsold at the end of the consignment period, the retail store will return them to the artist. The wholesaler can then decide whether to retrieve the unsold stock or extend the consignment. Here, the consignment allows the antique wholesaler to promote their products in a retail setting while saving inventory storage and warehouse costs. Meanwhile, the home decor store can offer a wide range of products to their customers without investing in maintaining inventory. 

Consignment Inventory Accounting

Consignment Inventory Accounting 

Let’s continue with the above example of the antique wholesaler and home decor retail store. Suppose, in the next batch of consignment, the wholesaler decides to send 100 units of his limited edition pottery sculptures to the retail store, at a cost of $10 per piece. So, the total value of the consignment inventory is $1000. However, the wholesaler will still own the inventory, so it will remain in their balance sheet. 

Antique Wholesaler’s Balance Sheet

Inventory (Asset): + $1000

Home Decor Store’s Balance Sheet

No changes (Since they don’t own the stock) 

Now, the retail store sells 60 sculptures to customers, for $15 each, totalling $900. 

Home Decor Store’s Balance Sheet

Revenue: +$900

Next, the retail store will report this sale to the wholesaler and pay them the fee decided during signing the consignment agreement. For the wholesaler, they are entitled to get back the cost price, ($10), and a commission of $2 per piece sold. So, the retail store will owe the wholesaler $720 (60 pieces x $12)

Home Decor Store’s Balance Sheet

Accounts payable (liability): +$720 

The artist will now recognize the revenue from the consignment sales and reduce the inventory by the COGS (Cost of Goods Sold), that is, $600 (60 pieces x 10 = $600). 

Antique Wholesaler’s Balance Sheet 

Inventory(Asset): +$400

Accounts Receivable(Asset): +$720

Revenue: +$720

Finally, the retail store will pay the amount due to the wholesaler, thereby settling their liabilities. 

Home Decor Store’s Balance Sheet

Cash – Asset: -$720

Accounts Payable – Liability: 0

Antique Wholesaler’s Balance Sheet 

Cash – (Asset): +$720

Accounts Receivable – (Asset): 0

This is a simplified example of consignment inventory accounting entry. The actual one would also involve recording the cost of goods sold, freight costs, adjustment for goods lost in transit, unsold stock, returns, and more.

Snapshot Antique Wholesaler’s Accounting Statement

Snapshot of Home Decor Store’s Accounting Statement

How To Manage Consignment Inventory?

Maintaining an accurate consignment inventory is no longer a choice, but a deal-breaker for suppliers and retailers alike. It becomes more complicated when retailers sell consignment goods as well as non-consignment goods at the same time. Most businesses still rely on spreadsheets-based legacy systems, making inventory tracking slow and unreliable resulting in unsuccessful collaboration between consignor and consignee. 

While there are numerous inventory management solutions available, not all of them are robust enough to seamlessly manage consignment inventory. Some challenges that retailers face are related to t effectively tracking consignment inventory, replenishing stock at the right time and ensuring a seamless working capital management. 

More importantly, they must pay special attention to the working capital problems owing to: 

• Delayed revenue recognition
• Increased costs due to maintenance of inventory levels. 

Therefore, the key to addressing these challenges is to implement inventory management systems customized for consigned goods. This will help to optimize working capital by: 

• Identifying the right products to purchase. 
• Reducing excess inventory at retail sites. 
• Minimizing shipping costs. 

There are a host of reasons why streamlined inventory management and favorable supplier terms are required for proactive working capital management. Retailers need timely restocking, while suppliers must ensure none of their funds are held up unnecessarily.

Advantages of Consignment Inventory

Consignment inventory comes with innumerable benefits for both suppliers and retailers if executed well. Here are some of them: 

Consignment inventory benefits for suppliers 

• A comprehensive visibility 

  Consignment helps suppliers reach new target markets by selling their products through local or boutique retailers. This also enables them to supercharge their revenues without investing in additional retail space or human resources to manage those new stores. 

• Test new products in a new target market 

  A consignment is an excellent tool for suppliers who want to introduce new products in new territories without hefty investments. This helps them understand the products’ performance, the audience’s adaptability and acceptance of the product, and how much revenue it would be able to generate. 

• Lower inventory costs

  Heavy inventory on the floor means tied up working capital and lower chances of moving it out to customers. Consigned goods can help reduce carrying costs to a great extent and get them sold through retail partners. 

Consignment inventory benefits for retailers 

• Lower financial risk 

  Retailers often lose their working capital as they keep buying surplus inventory. But in consignment, they are not paying for the inventory until they sell it. This l allows them to stock new products even with tighter profit margins and avoid the financial risks associated with unsold inventory. 

• Increased sales possibility 

  A consignment agreement helps diversify a retailer’s product lines and pool in customers. It will also help small retailers stay updated with current trends by introducing new products at zero inventory costs and tapping into unexplored territories. 

• No need to store inventory 

  The best thing about consignment inventory is that retailers don’t need to overstock products. They can replenish products only when there is customer demand. This saves the storage cost, while enabling them to return inventory that doesn’t sell. 

Improves retailers’ cash conversion cycle 

Cash conversion cycle is the time taken by a retailer to sell the consigned goods and pay the supplier. An efficient consignment inventory management will help them to not only streamline their cash flows but also ensure a shorter cash conversion cycle, thereby saving their working capital for urgent business needs and mission-critical tasks. 

Disadvantage of Consignment Inventory 

Despite the wide range of benefits, consignment inventory comes with a set of disadvantages for both suppliers and retailers. 

Consignment inventory disadvantages for suppliers 

• High expenditures

  Suppliers often have to bear quite a lot of expenses, including shipping costs, consignment warehouse costs, expenses for dedicated floor space in the retail store, charges for damaged items and lost-in-transit goods, and more. 

• Unpredictable sales

  Suppliers have to completely rely on the ability of retailers to sell their products. Since the retailers bear little to no financial risks, it’s difficult to know if they are applying all efforts to sell the goods. 

• Unpredictable cash flows 

  Suppliers often have to keep waiting for retailers to pay for their goods. Worse still, they also receive less money than anticipated if the goods are unable to cut through the market and are dependent solely on retailers to sell them to customers. 

  One of the most effective ways to cushion the loss of late payments from retailers is to use AI-powered advanced forecasting methods for account receivables. These solutions make the best use of AI-based cash forecasting for AR, scanning across bank statements, retailer invoices, promise-to-pay information etc., and help you navigate contingencies. 

Consignment inventory disadvantages for retailers 

• Receiving damaged stock 

  The longer a retailer keeps stock on the floor, the greater the chances of goods getting damaged due to wear and tear. In which case, retailers would then have to bear the cost of those damaged consigned goods, even if they are unsold. 

• Harder to manage consignment inventory

  If retailers are not clear about how to track consignment inventory, it can lead to confusion between the two parties. There can be disputes over the inventory quantity and items not arriving as anticipated. 

• Additional costs

  Sometimes, the consignment agreement may require retailers to cover certain costs related to protection or pilferage of goods and damage of goods during return. 

Consignment Inventory Best Practices

Managing consignment inventory often becomes complicated if retailers and suppliers don’t have a proper inventory mechanism in place. A successful consignment inventory calls for careful planning, agreement execution, and communication. Here are a few ways that can help suppliers and retailers enhance their consignment inventory management and achieve long-term success. 

• Build a strong consignment agreement 

  A robust consignment agreement is the key to a successful consignment arrangement. Suppliers and retailers, both, should be on the same page and understand the terms of the contract. This will include shipping, costs incurred for damaged goods, time of payment, and responsibilities for returning the consigned inventory. It can also include how to track a consignment and methods to count inventory and inventory costs.

• Form an effective pricing strategy 

  This is a critical part of consignment management to ensure no party is earning less than what they should. Suppliers and retailers must ensure that the pricing boosts profitability while drawing customers towards consignee retailers. Factors like cost of goods, competitiveness, market demand for the product, etc., play a critical role in determining the price of the stock. 

• Deploy an agile and robust consignment inventory management system 

  Many retailers and suppliers are still following legacy methods like spreadsheets to keep track of their consignment inventory. This is not only a time-consuming manual process but also paves the way for errors. Today, there are many inventory management systems, powered by automation and machine learning, that can help streamline the consignment process and provide accurate consignment inventory insights right at your fingertips. 

• Don’t rely on a single channel for sales 

  Not all consignment relationships will work the way you would like them to. Consignors and consignees often fall out because of discrepancies like who will bear the cost of damaged or lost inventory, how much of the profit to retain, and so on. Collaborating with multiple consignment partners is one of the most effective ways to navigate this. This will help reduce the risk while diversifying your channels and customer base.

• Regular Communication 

  Retailers and suppliers should foster healthy and regular communication so there are no differences in records for consignment sales, inventory levels in the consignment store, and any adjustments needed to streamline cash flow. They should regularly review and renegotiate consignment agreements that best fit the evolving market and business needs. 

• Keep your cash flows in check 

  We have previously covered in detail how consignment inventory boosts your working capital. But at the same time, if retailers and suppliers fail to maintain accuracy in the process, it can also create cash flow bottlenecks. Both parties need to ensure: 

  • Regular and close monitoring of inventory levels so there’s no overstocking of consignment inventory. This could lead to tying up excess cash in unsold goods.
  • Improving inventory turnover, by moving the goods from the retail floor as fast as possible. This will help retailers minimize their inventory holding costs and maximize their cash flows. Implementing strategies like promotions, markdowns, or bundling to incentivize sales can help promote consigned goods and make them attractive to the customers. 
  • Negotiate consignment agreements that favor both suppliers and retailers. Suppliers must be able to get timely payments against their account receivables, while retailers must not reduce their working capital. 
  • Streamlined payment procedures to eliminate unpredictability in cash flows. For instance, retailers can ask suppliers to go for a longer payment term. Or suppliers can negotiate for a lower commission rate. This will help maximize revenue, ensure timely payments, and reduce the time inventory spends sitting on shelves. 

How HighRadius Can Help to Streamline Cash Flow?

One of the best ways for suppliers and retailers to address cash flow concerns in consignment inventories is to streamline your daily cash positioning by upgrading to automated cash management tools. Keeping this in mind, HighRadius brings you out-of-the-box solutions for  daily cash positioning. These applications help optimize cash flow management by recording and managing planned cash transactions and view all cash transfers at one place. 

FAQs

1) What is a consignment store? 

When we say consignment store, it refers to a retail store that sells pre-owned goods as a portion of its sale price. Customers bring in things that are no longer needed. The consignment store will sell them on their behalf and pay the due amount once the items have been sold.

2) What are the risks of consignment inventory?

Consignment inventory poses numerous risks, like higher costs of storing goods, shipping costs for suppliers, goods getting lost in transit, unpredictable cash flows due to late payments from retailers, risk of damaged inventory, absence of a single and accurate inventory tracking method, and more.

3) How do you account for consigned inventory?

Steps to account for consigned inventory:

• Debit consignment inventory and credit store stock at the initial transfer.
• Record sales when retailers sell consigned goods.
• If unsold goods are returned, debit store stock and credit consignment inventory.
• Record payments by retailers to suppliers.

4) What is the legal definition of consignment inventory?

The consignment definition explains consignment inventory as the arrangement where a supplier delivers goods to a retailer to sell. The supplier will retain ownership of goods until sold. The retailer will pay the supplier once the goods are sold, keeping aside their portion of the profits.