In a consignment agreement, a consignor is a person who sends the goods to a person called the consignee. This is done in an arrangement to sell or deal in goods on behalf of the other person in exchange for a commission for every sale.
Did you know? In a consignment agreement, the consignor is the true owner of the goods while the consignee is merely an agent acting on behalf of the consignor while dealing with customers.
What Does a Consignment Mean?
The concept of consignment is used to where a party arranges for a third party to receive and sell their products. The third-party seller receives a commission on the sales. This arrangement is used for various products such as artwork, clothing, accessories and books. Some kinds of retail sales might be seen as a special form of consignment. In such cases producers depend upon retail stores for selling the products to consumers. Selling through consignment agreement should be a low-commission, low-time investment method for selling items or services but could be costly.
What is the difference between Consignor and Consignee?
A consignor is the owner of goods that are sent to a consignee to be sold to a third party. It means the consignor has a record for consigned inventory over books until it gets sold to a third party.
Consignee on the other hand is the recipient of goods that are shipped by consignor. The consignee is accountable for selling the goods to a third party after which the consignee pays the consignor and retains a commission.
Example of What is a Consignor in Different Industries
1. Mobile Industry
In the mobile manufacturing industry, the manufacturer agrees to sell the products on e-commerce platforms like Amazon or Flipkart in the consignment agreement, where the mobile manufacturer is the consignor.
2. Automobile Industry
In the automobile industry, the manufacturer acts as a consignor to send goods to automobile agencies. And for every automobile sold, the agency owner receives a sum on sale as part of the commission.
Antique articles are usually auctioned through ways of consignment. The payment is done in exchange for a commission on the price at which the auction had concluded.
How Does Selling on Consignment Work?
Consignment selling usually begins with making arrangements with the consignee about the number of articles they can sell in a given time frame. Once the quantities are decided, the consignor sets the commissions. It could be on a per unit sold basis or in the form of a royalty of a certain percentage of total revenue generated.
While the terms of the agreement may be different in different arrangements, the underlying principle is that the consignee will work on a commission basis. Up next, when the consignor pitches the idea of stock management, it could be decided after what time the goods will be returned to the consignor if left unsold. The terms may call for penalty if the goods are not returned within the stipulated time frame.
Once the terms are established and agreed upon, the consignor releases the goods at an agreed quantity. For these goods the consignee is not required to pay upfront but will only pay if the sale is materialised and the consignee receives the cash from debtors. Periodic return statements are usually released by the consignee for inventory deposit and sale, for which settlement will be assessed by the consignor in response to check on asset misappropriation.
The consignor is usually motivated to enter into consignment due to the elimination of possibility to open a physical store upfront, which in turn reduces the cost for the consignor. Other benefits could include reduced inventory and storage costs and overheads in terms of non-existence of large infrastructures.
Responsibility of a Consignor
The responsibility of consignors could be as follows:
- To pay for expenses incurred to the consignee in course of the consignment.
- To send goods to the consignee.
- To pay the sum of money as communication for sales.
- To ensure that the goods are available on a timely basis to the consignee.
- To supply good quality products.
- To resolve complaints from consignees.
- To provide sufficient quality of goods to the consignee.
Benefits to the Consignor
The consignment agreement expands and opens up a new market for consignors. It allows the consignors to place their products in different geographical locations without incurring a huge fixed cost of establishing their own unit. This way they could save huge capital expenses and earn substantial profits at reduced risk. Here are a few of the benefits of a consignment agreement for the consignor.
- The consignor would not be required to establish their business units rather they could use the place of the consignee to market to new geographical locations.
- The consignor is at reduced risk since only a small working capital is used in financing the stock of goods.
- The consignor would be relieved from daily operational decisions, as it could be the responsibility of the consignee.
- The consignor could expand their business to different locations at a much-reduced cost as the capital expense could be avoided.
The Forms of Consignment Agreement
Modern day consignment agreements have gone through various changes since legal complexity in the business has increased over time. However, small businesses still follow the conventional form of consignment. Here are a few forms of consignment:
In modern-day consignment agreement, franchising is based on a marking concept where an organisation shares its know-how, intellectual property, procedures, and brand image with a franchisee. In return, the franchisee pays a sum of money as royalty on sales, subject to fulfilment of certain contractual obligations and duties. Adopting a model of franchising gives an advantage to the business to operate at low capital investment and liability risk.
It is often seen in the food chain industry wherein the franchisor shares its intellectual property rights and know-how with its franchisee to operate as a business unit but not independent from the underlying chain.
It is worth noting that the franchisees are small businesses having largely formed as individual proprietorships or partnerships and are in corporate form. In contrast, for example - Jubilant FoodWorks Ltd. owns the franchise rights for Domino’s pizza and Dunkin Donuts for operations in India, Nepal, Sri Lanka, and Bhutan.
It is quite often seen that companies want to have control of their supply chain through consignments since a large volume of goods is traded through retailers on credit. A strong supply chain creates a competitive advantage for companies as seen in the FMCG (Fast Moving Consumer Goods) industry. For example- due to so much control of the supply chain by HUL, P&G, NESTLE, Patanjali, and other players, new entrants are reluctant to enter the FMCG market.
Auctions are one of the oldest forms of consignment selling wherein a person called an auctioneer offers a bid to a group of buyers and then sells the goods to the highest bidder. Auctions are applied for different trades in diverse contexts. For example - The assets of a company going through liquidation may be sold through auction by the creditors. Similarly, a private auction may be organised by an Individual to sell an antique to get the best price for it.
What Are the Limitations for a Consignor?
- The consignors are usually left with a huge risk of stock loss as the stocks may not be sold on time and could perish their value over time.
- There may be instances of huge cash crunch for the consignor as a large part of liquid assets may be blocked with inventory laying with the consignee.
- Inventory holding costs may pile up which could otherwise be avoided if proper inventory management was in place by the consignee.
- In the case of a franchise, there is an underlying risk that the confidentiality of business and trade secrets may not be maintained by the franchisee which could severely affect the business.
- The consignor may be left with a low-profit margin since the commission costs add up, leading to low profitability.
Consignment is still the most conventional but popular form of business expansion. Especially for small and medium enterprises due to its easy feasibility in terms of financing the expansion. Also, there are already pre-established legal frameworks to govern the operation and structure of the business model. However, there are practical limitations for a consignment form of business expansion. The most notable is the blocking of working capital in stocks and the risk of stock loss in terms of perishing a large part of the value of the stock.
We have been through what is a consignor, who a consignor is, the consignor definition , the role of the consignor, various forms of consignment, practical limitations for consignors, etc. Hope this article gave you an insight into how the consignment agreement works and what does a consignor mean.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.