Consignment Stock

Consignment Stock refers to a business model where a consignor (a vendor or wholesaler) agrees to deliver goods to a consignee (usually a retailer) for sale. This arrangement usually takes place without the consignee paying the consignor for the goods upfront. The consignor retains the ownership of the goods till they are sold. Any unsold stock is returned to the consignor by the consignee.

This arrangement is sometimes referred to as consignment inventory, and it benefits consignors and consignees alike. However, specialized systems and accounting procedures are required to handle such stocks. This approach to inventory management is a low-risk activity for both parties. It allows consignors to enter new markets without incurring inventory costs, while consignees can offer a wider variety of products without purchasing them from the consignor for the purpose of sale.

• Consignment stock involves a consignor delivering goods to a consignee, with the consignor retaining ownership until the goods are sold. 
• A consignment stock agreement should include specific terms regarding returns, shipping expenses, commission rates, and freight policies to prevent potential losses and friction between the consignor and the consignee.
• The valuation of consignment stock is treated as a separate arrangement, with the consignee recording it as a liability until the goods are sold. It is a great option for retailers and suppliers who wish to share the risks and rewards of sales.
• Both consignment and call-off stock are inventory management strategies that allow businesses to store goods in a manner that reduces lead times and improves delivery efficiency. However, differences are seen in the context of ownership titles, warehousing terms, and payment clauses.

Consignment stock involves a business arrangement where a supplier (consignor) entrusts goods to a retailer (consignee) who stores and sells the goods on the supplier's behalf. The consignee pays the consignor only for the sold goods, while the consignor continues to own the unsold items. This arrangement helps both parties minimize risk, manage inventory, and capitalize on sales opportunities.

Consignment refers to a scenario where one business sells goods or items on behalf of another. This can involve various combinations, such as a retailer and wholesaler, two retailers, or even a retailer and an individual. The revenue from sales is divided based on a contract agreed upon by the parties involved. Such contracts are commonly seen in retail, fashion, art, and furniture, among other fields.

A consignment stock contract, also known as a consignment agreement, is a legally binding document that outlines the terms and conditions for storing, transferring, and selling the consignment inventory. It specifies the distribution of profits between the consignee and consignor when the goods are sold. Certain aspects of such agreements are clauses on ownership retention, risk allocation, consignment responsibility, and payment structures.

Consignment goods are stored in a retailer's warehouse. The consignee is accountable for consignment stock management and the sale of these goods. Consignors count these goods in their inventory. Consigned inventory is only for supplier-owned items for sale by the retailer. Goods held on consignment are never owned by the consignee, included in the consignee's ending inventory, or kept for sale on the consignor's premises.

A mutually agreed-upon consignment stock contract between consignors and consignees is crucial to prevent potential miscommunication and losses. It also facilitates consignment stock management.

Every contract has the following basic clauses at the least:

• A specific return policy for unsold or rejected items to prevent unnecessary loss at the consignee’s end.
• The exact breakdown of shipping expenses is crucial to ensure no party suffers undue losses. The terms and conditions of the company's freight policy should be included.
• A fair commission rate for sales is established to ensure the consignor gets their due share.

Contracts without these specifics run the risk of resulting in miscommunication and causing considerable losses for both parties.

Let us study a few examples to understand the concept better.

Example #1

Daisy, a businesswoman, enters into a consignment stock agreement with a retailer, ABC Ltd., for the sale of the apparel she manufactures. She provides ABC Ltd. with her products, and the retailer displays and sells them. Daisy retains ownership until the products are sold, and the retailer pays her for the sold items. If any items remain unsold, she can request their return. 

This arrangement allows Daisy to expand her market reach while minimizing inventory risk. It also enables her to focus on production while the retailer takes the responsibility of selling the goods she manufactures.

Example #2

According to an April 2023 report published by CNBC, Bed Bath & Beyond, the popular US retail chain entered into an agreement with Hilco Global to address bankruptcy issues and prevent further financial turbulence. This strategic decision is expected to pull the company out of its current business troubles.

Bed Bath & Beyond entered into a consignment agreement with ReStore Capital, which is connected with Hilco, to accelerate the sale of its products. Around $120 million will be pumped into the retail distribution function to increase sales across its many locations.

Bed Bath & Beyond CEO Sue Gove said the consignment agreement will help the company mitigate financial and operational risks while enabling it to manage all inventories well. With this arrangement, Bed Bath & Beyond’s investment in inventory was expected to remain low, facilitating order fulfillment and strengthening the supply chain.

The advantages and disadvantages of this system have been discussed below.

Advantages

For Consignors

• Market interest testing: It helps test market interest in products before committing to large quantities.
• Streamlined supply chain: It streamlines the supply chain, reducing costs and eliminating excess inventory.
• Relationship management: It helps consignors build strong relationships with retailers as they take risks, and this increases loyalty.
• Cash flow optimization: It increases cash flow by selling off consigned stock and making room for new inventory.
• Marketing support: Product visibility and exposure increase as the customer base grows with such an arrangement.
• Marketing research: It helps consignors gain insights into product trends and optimize production for maximum profit.

For Consignees:

• Product diversification: Consignees get access to a wider variety of goods to offer their customers, which results in diversification and sales boosts.
• Proportionate risk-taking: It is a cost-effective arrangement, as consignees only pay consignors for the goods they are able to sell and can return the rest per the terms of the agreement. This helps them avoid inventory losses.
• Marketing boost: It boosts product visibility and offers promotional opportunities. It also helps them expand their product range and offer unique items to buyers.
• Cash flow support: It increases cash flows for them since they sell consigned stock and earn profits.
• Supplier liaison and relations: Building stronger relationships with suppliers through shared objectives is possible through such arrangements.
• Low-cost business: Payments to the consignor are issued only for goods that a consignee sells, which reduces their initial outgo. Also, inventory costs are controlled since suppliers take responsibility for inventory restocking, ensuring optimal stock levels.

Disadvantages

For Consignors

• Risky approach: Consignors take on significant risks by providing a large amount of stock to retailers. If the products do not sell well, the consignor may incur financial losses and face the need to expand inventory.
• Little to no control on pricing and marketing: Per consignment contracts, consignors typically have less control over product prices and promotions since these become the retailer or seller’s responsibility.
• Lower profit margins: Since only a portion of the sales proceeds are passed on by the consignee to the consignor, profit margins are low.
• Disputes over distribution: The chances of disagreements with consignees regarding the use of distribution channels are high.
• Other disputes: Many other reasons could cause disputes, such as responsibility for goods damage or losses, inventory management approach, etc.

For Consignees:

• Low visibility: New consignment products can have low visibility, making them challenging to sell. Marketing efforts are required to attract potential customers.
• Higher carrying costs: Retailers are responsible for collecting inventory from the warehouse, resulting in higher carrying costs. They also incur additional expenses for storage and upkeep, affecting their margins.
• Cash flow issues: Retailers cannot collect payments until the products are sold, which can create cash flow challenges and restrict immediate access to funds.
• Increased inventory management challenges: Consignment inventory requires separate tracking and management, creating complexities for retailers. Sales monitoring, consignment stock accounting, and consignment restocking (from the supplier's warehouse) can be challenging.
• Difficulty in tracking margins: Since consigned items do not involve upfront supply costs, it can be difficult for retailers to track their margins accurately.
• Low profit generation: As consignees share a specific portion of the sales proceeds with the consignor, they are unable to post adequate profits.

The differences between the two are listed in the table below.

This article has been a guide to Consignment Stock and its meaning. We explain its agreement, examples, comparison with call off stock, advantages, and disadvantages. You may also find some useful articles here -

• Consignment Accounting
• Vendor Managed Inventory
• Spoilage