What is Inventory Financing?
If you have cash flow problems but need to purchase inventory, consider inventory financing. Use this type of loan to buy inventory, while also leveraging it as collateral.
Suitable for retailers and wholesalers, inventory financing provides cash amounts exceeding those of other nontraditional bank loans and invoice factoring.
Inventory financing is similar to asset-backed revolving lines of credit and term loans, but the asset used for collateral must be your purchased inventory. As the lender will need to assess your inventory operations, these loans require a thorough application process, possibly involving a third party. Given the effort required, lenders generally won’t waste time with loan requests less than $500,000-$700,000.
How Does Inventory Financing Work?
Lenders will typically advance 60-90%* of your purchased inventory’s liquidation value (as opposed to market value) through a line of credit or a term loan. With a line of credit, you can draw funds when needed, and make interest payments to restore the maximum limit. With a term loan, you’ll get a lump sum upfront and pay it back in monthly installments.
*Note that this means they can seize 100% of your collateralized inventory, while only advancing you 60-90%.
As with any “secured” loan, lenders have a right to seize assets upon default. In this case, they’d seize the inventory you bought with the loan. Many business owners may feel more comfortable taking a loan backed by inventory, as opposed to cars, property or invoices. After all, they figure, if the product can’t be sold, what do they lose anyway?
However, lenders also understand this logic and will practice extreme due diligence evaluating applicants’ inventory and business operations. While the loan itself is pretty straightforward, the application process leading up to an agreement (or rejection) requires patience and an understanding of risk assessment.
Why Use Inventory Financing?
Before seeking a loan, first, see if your supplier will allow you to buy on credit. This is obviously a simpler arrangement and likely to be cheaper. If this is not an option, definitely consider a third-party source of funding.
Before applying for inventory financing, you should first determine whether you’re a suitable candidate. Otherwise, you may get tangled in a lengthy application process only to be denied.
Inventory financing can be ideal for wholesalers, retailers, or any company that purchases inventory and sells products. Service industries will not qualify.
As usual when shopping for loans, first determine whether you’re eligible for a traditional bank loan. If not, and you’re seeking to purchase inventory worth at least $500,000, inventory financing could be the solution to your cash flow problems. For instance, if you’re car dealership looking to fill up your lot before the busy season, inventory financing could be perfect—especially if you expect quick proceeds to cover the loan.
Another question to consider is how much lender involvement you can tolerate. From the start of the application up until the loan is repaid, you can expect ongoing paperwork, inspections and appraisals, possibly even unannounced visits. With regular business lines of credit and short-term loans, however, after the initial check of your credit score and a few other financial documents, you’ll be left alone, as long as you repay.
Whether or not you should use inventory financing may come down to preferences. If the loan amount you need requires collateral, you may be happy to put up the purchased inventory if you deem your other assets ‘untouchable’. But some business owners just don’t have the time to get approval or the sales prospects to pay off such an expensive loan.
Pros of Using Inventory Financing
Obtain a significant loan amount (more than $500,000)
Use purchased inventory as collateral rather than cars, houses, invoices, etc.
Get the built-in incentive to sell your products!
Cons of Using Inventory Financing
Pay higher interest rates than you would on traditional loans
Expect frequent inspections and appraisals (sometimes unannounced)
Get a loan of only 60-90% of your collateralized inventory’s value
Inventory Financing Rates, Cost & Terms
Inventory Financing rates range from 8-35%. Generally, the less the lender will advance, the lower the interest rate. The lower the interest rate, the more due diligence. Banks will only fund up to 60% of the inventory value, but offer rates in the single digits. They will also spend at least a few weeks–possibly a few months on appraising your inventory. Other lenders, however, may be willing to fund up to 90%, but rates will be substantially higher. While they’ll also practice due diligence, their approval process will likely last from 1-3 weeks.
Part of what makes inventory financing expensive is its duration of only one year, which is a relatively short time to pay back the loan with interest. In addition, you can expect fees for inspection and appraisal.
Some non-traditional lenders advertise “inventory financing”, but you’ll be puzzled to find no collateral required. After all, isn’t the point of inventory financing to leverage purchased inventory as collateral? Don’t be fooled by the gimmick. This just a regular line of credit or short-term loan dressed up as “inventory financing” for marketing purposes. They’re merely targeting business owners who want to boost their inventory. The loan is advertised to free up cash flow to purchase inventory, but in reality, borrowers can use it on anything, as long as it’s repaid.
How to Apply (and hopefully qualify)?
To be considered for approval, your desired loan amount should be at least $500,000. Again, lenders won’t invest the time appraising your inventory for anything less.
Your lender also needs to know that your inventory is liquid and marketable. Despite what you pay for your inventory, the lender needs to know that it can be turned into cash, should you default on the loan. This is what prolongs the application process, as the lender and/or third parties evaluate your products, inventory management system, loss or damage rate, profit margins, and turnover. Keep in mind that even after initial approval, lenders may wish to repeat inspections every 3-6 months.
You’ll also need to provide financial statements, tax returns, proof of business ownership, credit score and other relevant documents showing the health of your company. Inventory financing is not ideal for start-ups or new businesses with less than a year (or more) of consistent revenue.
As inventory financing is usually a second or third option, lenders will often ask if you’ve first considered other forms of alternative financing. Therefore, it may help to read our guides on regular business lines of credit, short-term business loans and invoice factoring.
If inventory financing is the type loan your business needs, our manging director would love to help you with the application process. Contact us now.