I recently received a question about how to determine the vendor costs of consignment inventory. I thought I would take the opportunity to outline the costs in this post. This is the third post concerning consignment inventory on this blog. I will provide links to the other two posts later on. First, when it comes to discussing vendor costs of consignment inventory, it’s important to remember that the consignment inventory at the customer’s location is still owned by the vendor, not the customer. The customer is only invoiced for what they use in a given month – the remaining unused inventory is still owned by the vendor. In this case, it’s as if that remaining unused inventory is still in the vendor’s warehouse. As such, the same inventory holding costs that vendors deal with every month, apply to the consigned inventory.
Most inventory professionals state that a company’s monthly inventory carrying charges are approximately 3% of the inventory’s value. These costs are made up of a number of factors including the cost of money, damage to inventory, obsolescence, cost of freight, overtime etc. To use a sample excel sheet that defines these holding costs, and helps you define your own, please refer to: Sample Inventory Costing Excel Sheet: Graph & Pie-Chart of Expenditures
These inventory holding costs still play a vital role in a vendor’s costs of consignment inventory. Again, it’s as if the inventory were still at the vendor’s location. As such, this 3% monthly inventory holding cost still applies for all unused consigned inventory. It’s this 3% that erodes a product’s gross profit over time. This is because the vendor has paid for the inventory, but has yet to invoice their customer. To clarify this, think of what your company must do to support your inventory. Your company likely uses business loans and credit lines to finance the purchase of your inventory.
The yearly interest rate on these loans can be broken down into a daily interest rate. It’s this daily interest rate that erodes the product’s gross profit every day it remains in you inventory and isn’t sold – because you’re still paying that daily interest rate on the value of the inventory.
The table and video above explains how a consignment inventory agreement works and is from the post: “Supply Chain Management: Pros & Cons of Consignment Inventory”. In it, I discuss the pros and cons of consignment inventory from the mindset of the vendor providing the inventory, and the customer receiving the consignment inventory. This post contains a table of what a consignment inventory agreement might look like. It shows how the consignment inventory is invoiced to the customer and what portion remains owned by the vendor in each month of the agreement. That unused inventory is still owned by the vendor, and therefore falls under the same inventory holding costs of 3%.
My second post was entitled, “Consignment Inventory Invoicing & Transfer of Ownership”. This is more about what vendors and customers must agree upon when it comes to the how and when inventory is invoiced. It looks into the logistics of managing consignment inventory for vendors, and discusses when the ownership of the inventory is transferred from vendor to customer – if it is transferred!
There are a number of variables when considering consignment inventory. There are benefits and drawbacks for both customers and vendors. However, it’s essential that both have a clear understanding as to the liabilities within the agreement.
When thinking about the costs of consignment inventory for vendors, start first with understanding your company’s current holding costs of inventory. This same cost applies to the unused consigned inventory at your customer’s location. Finally, make sure you come to an agreement about how and when invoicing will take place or how much you require as a minimum monthly or quarterly consumption amount for your customer.
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