If you’ve ever offered to sell something for a friend for a cut of the profits, congratulations you’ve been a part of a consignment sale.
The consignment inventory supply chain model is used by more than friends and mom-and-pop clothing stores (see what is inventory). It is used by many large retailers and wholesalers to boost profits and limit costs.
But, how exactly does consignment work, and what sets it apart from other inventory models like dropshipping and kitting? We'll explain it all, including some advantages and disadvantages so you can decide if it's right for your business.
How Does Consignment Work?
Consignment is when one business (consignee) or store sells goods on behalf of another (consignor). These two parties may be a retailer and wholesaler, two retailers, or even a retailer and an individual. Sales revenue is split according to a contract signed between the two or more parties. You can often find these wholesalers on an online marketplace.
The consignment model of inventory management requires multiple organizations to work together when selling goods. The model features a retailer that stores and sells the goods in question and one or more suppliers who own the goods. Upon sale of the goods, the consignee receives a portion of the profits while the consignor receives the rest.
What Is Consigned Inventory?
Consigned inventory is the items held and sold by one business for another. Consigned inventory is held in warehouses intended only for inventory owned by the supplier for sale by the retailer.
Who Owns Consigned Goods?
Consignment goods are stored in the warehouse of the retailer, but ownership of these goods is retained by the consignor. The responsibility for maintaining and selling them falls on the consignee. The consignor also counts these goods in their physical counts of inventory.
Quiz: Goods Held On Consignment Are
Were you paying attention to how consignment works? Let's find out with a quick quiz.
Goods held on consignment are:
- Never owned by the consignee.
- Included in the consignee's ending inventory.
- Kept for sale on the premises of the consignor.
- Included as part of no one's ending inventory.
If you chose A, you’re correct. Nice work!
Consignment Stock Contract
A consignment stock contract, or consignment agreement, is a legal document outlining the agreement between a consignee and consignor in regard to consignment goods. This contract outlines the requirements for storing, transferring, and selling the consignment inventory. It also includes the amount of profits received by each party when the goods are sold.
Benefits of Consignment Inventory
Consignment inventory provides a slew of benefits to both the supplier and retailer.
Consignment Benefits for Suppliers:
- Builds relationships. Consignment requires suppliers and retailers to work together and maintain contact regularly. This builds their ability to work together and grow sales for each other.
- Gets product visibility. More customers can be exposed to a supplier's product through consignment than if it was distributed through traditional methods.
- Reduces inventory costs. You should have enough inventory to cover sell through and any safety stock or anticipation inventory. If you find yourself with inventory issues, it might be time to switch to the inventory cycle count method. Holding a large amount of merchandise inventory is expensive. With consignment, all storage costs are the responsibility of the retailer.
- Gives insight into product trends. Suppliers can track their consigned inventory sales to discover what products convert and within how long. This allows a supplier to invest in the right good and only hold the most beneficial raw materials inventory to make the most profit.
Consignment Benefits for Retailers:
- Increases the product range. Sales increase when customers are offered the broadest product assortment. Consignment gives them access to a variety of unique products for minimal cost. Consignment is a great way to find products for subscription boxes as well.
- Only pay for sold goods. Unlike traditional inventory, consignment inventory is only paid for once a customer purchases it. That means a retailer can maintain a large safety stock for very little cost.
- Inventory restocking mostly falls on the supplier. Suppliers have a lot to lose if their product is on backorder since they don't get paid upfront. This means suppliers stay on top of stock levels and try to keep them at optimal levels for the retailer.
Consignment Inventory Management
A consignment inventory management strategy revolves around a supplier and retailer working together to sell the supplier's goods. This involves shared sales information and profit as well as the use of a dedicated consignment warehouse. The supplier must track product trends, find good bulk shipping providers if necessary, ensure stock levels are optimal for the retailer to sell.
What Is a Consignment Warehouse?
Consignment warehousing is any facility set up by a supplier used solely to store consignment goods for a retailer. It is generally set up on or near the property of the retailer, so they can have quick and easy access to the goods. A consignment warehouse does not contain any inventory owned by the retailer. Like just in time inventory, this keeps the storage costs of retailers low.
Vendor Managed Inventory and Consignment Stock
Vendor managed inventory (VMI) and consignment stock are terms that are often used interchangeably, but are not the same thing. Ownership of goods, warehouses, and the way sales are handled are all different between these two inventory methods.
Vendor Consigned Inventory
In the vendor managed inventory model, the vendor/supplier manages the inventory supply, but the retailer owns it. This inventory resides with the retailer, but they don't handle the management, maintenance, or purchasing of the goods.
Vendor Managed Inventory vs Consignment
There are a number of similarities and differences between vendor managed inventory and consignment inventory. Both VMI and consignment inventory management techniques requires communication between the retailer and seller and involves shared information regarding sales. The supplier and retailer both stand to gain more in both methods by building a strong relationship. However, consignment inventory belongs to the supplier while vendor managed inventory belongs to the seller. This means suppliers have more skin in the game with a consignment model.
Consignment Inventory Accounting
Consignment inventory accounting seems like it would be a bit more complicated than other inventory methods, but it isn't. Both the supplier and the retailer must account for consignment sales, but not the inventory.
Consignment Inventory Accounting Entries
Goods held on consignment are included in the inventory of the supplier (consignor), not the retailer (consignee). Even though the goods are sold by the retailer and reside on or near their facilities, they never take ownership of the goods. The only time consignment inventory is accounted for by the retailer is at the point of sale. This is reflected on the balance sheet of the retailer. At this point, the revenue from the sale and the payment to the supplier are added.
Consignment Inventory Form
Tracking consignment inventory is an important responsibility of a supplier. We've made this easier by creating a free sample consignment inventory spreadsheet for you to use. Feel free to make a copy and begin using it to track all of your goods as they go through the consignment process.
Consigned, Sealed, Delivered
Now that you have the basics of consignment down, you can make an informed decision and continue to grow your business and increase your sales. Like embracing ABC inventory analysis, for example. Consignment inventory has many benefits for both suppliers and retailers and might be the right choice for your business.
Frequently Asked Questions About Consignment
After reading more about consignment, you probably have other questions about it. In order to get the most out of a business that uses consignment, we compiled some frequently asked questions. Check out our answers below:
How do you record consignment goods?
Consignment goods are recorded with a specific accounting process. When the consignor’s goods are sold, the consignor records this as a debit to cash and a credit to sales.
In consignment, a consignor agrees to transfer ownership of property to a consignee, who agrees to sell that property on behalf of the consignor. Therefore, their cash account increases based on the sold goods, and the sold goods count as an expense because they’re no longer held by either consignee or consignor.
What is a consignment item?
A consignment item is any product or property that has been transferred from a consignor to consignee with the intent of being sold. Upon transfer, the consignee’s retail environment helps sell the product, but the consigned item is still owned by the consignor.
Consignment is used to help product manufacturers and creators gain additional exposure to marketplaces that they otherwise wouldn’t have. This process can be risky at times as it requires manufacturers to front the cost for products that may not sell, but it pays off if their goods become desirable.
How do you price consignment items?
Consignment items are typically priced 25-40% higher than their purchasing cost. This additional margin is the consignee’s profit; without it, the consignee would have no incentive to sell the goods.
Consignees are encouraged to price goods for sale, which means their profit margin shouldn’t be so high that it deters consumers from buying the product. Consignment pricing requires a bit of finesse and understanding one’s customers to get just right.