Using Consignment Inventory to Improve Your Cash Flow

January 1, 2011
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One approach that is often overlooked for acceleration of cash flow is the use of consignment inventories. Consignment goes beyond VMI/SMI (Vendor Managed/Supplier Managed Inventory) in improving cash flow because with consignment you don’t pay for the inventory until you use it. With consignment inventory the customer takes possession of a supplier’s goods on receipt of a shipment but does not own them. The customer is responsible for maintaining these inventories as if they were their own, which means storing them in a safe and secure place and paying the insurance and other related storage costs. During a physical inventory, these goods are inventoried as “supplier owned inventory”. When the goods are removed from inventory several transactions occur. First, the quantity on hand in the supplier’s inventory location is reduced and transferred to WIP. Since this inventory was never on the books as an asset the cost goes directly to COGS as an expense. Next, a notice is sent to Accounts Payable to voucher a payment for the quantity used. Since no invoice was issued no three-way matching is required. Most important, the cash flow only reflects the amount of the transaction itself.

To illustrate this process:

One company the author worked with bought large amounts stainless steel coil from an-out-state supplier. Prior to consignment the buyer ordered this material in economic order quantities and in standard lead time based on their MRP system. Material was shipped by truck and received in 7-10 days. Often these shipments represented 3-6 months of usage (a drain on cash). Sometimes in an emergency the buyer even authorized air shipment for one or two coils (incurring a premium for shipping).

After going to consignment, the supplier took over planning and shipment of the material. The buyer provided the supplier their projected demand (MRP Report). With this information the supplier was able to schedule production more efficiently and optimize the use of their capacity. The supplier shipped full truckloads (at reduced transportation costs). No invoice was issued at the time of shipment. When the material was received it was put into a consignment inventory location at the buyer’s facility. The material handler pulled this material as required and issued one coil at a time to production. When a coil was issued, the material handler, processed an inventory transaction, and sent a notice to Accounts Payable showing the quantity issued, P.O. number and other significant packing list data. Once a week these forms were batched and payment was made to the vendor for the total amount of material used for that week. Consignment was a “Win-Win” for all parties concerned.

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