How Inventory Financing Works

If you open a store, how do you get the products to sell on your first day? 

This might be a basic question, but it raises a fundamental issue for any new small business or retailer. Assuming you don’t have the resources of Walmart or Macy’s, maintaining enough inventory to meet demand is critical for healthy cash flow—which, in turn, is important for any small business’s survival.

One option many companies turn to is inventory financing, which allows a business to borrow from the inventory it plans to sell in the future.

“Ideally, a company would always have cash on hand to buy inventory, but sometimes it’s difficult to fund operations with fluctuating cash flow,” Evan Guido, president of Aksala Wealth Advisors, told US News and World Reports. “Some businesses require massive inventory before they collect cash from sales, and retailers might need to stock the shelves before holiday shoppers start ringing the cash register.”

What Is Inventory Financing?

Inventory financing is a short term loan, or sometimes a revolving line of credit, used by a business to purchase inventory, i.e., goods, intended for sale later. The inventory itself is used as collateral for the loan.

As an asset-based form of financing, inventory financing is often tapped by businesses that operate on a seasonal basis to help ease cash flow concerns that arise when the business purchases or manufactures a large stock of inventory that won’t be sold until later in the season. 

Inventory financing shares similarities with equipment financing and merchant cash advances. With equipment financing, the equipment itself is used as collateral, and with merchant cash advances, the business’s daily credit card sales are collateralized.

How Is Inventory Financing Calculated?  

Lenders make decisions about inventory financing on a case-by-case basis. Not only will lenders look at a company and its financials, but they’ll also make decisions based on the inventory itself. Because of this, lenders offering inventory financing may specialize in specific industries or businesses.

“Lenders often specialize in particular industries because that knowledge helps them estimate the value of inventory and the likelihood of default,” Aksala’s Guido noted. “That expertise helps them offer lower rates or better terms.”

Inventory ranges in how it holds its value, since it’s affected by pricing trends, perishability, and macroeconomic swings. If consumer spending is down—for example, as it was in the wake of the 2008 financial crisis—inventory financing can be harder to achieve.

Additionally, inventory’s value may depreciate over time, all of which lenders consider before making approval decisions.  

Repayment Terms to Expect

Repayment terms for inventory financing can vary and may be determined based on the business itself, the inventory, loan size, and the overall state of the economy. 

Typically, inventory financing loans range from $5,000 to $500,000. The repayment period is generally short, often spanning 3 months to 1 year. Additionally, the APR or interest rate offered will depend on the business’s financial situation, industry, and overall economic conditions. 

Seasonal Businesses and Growing Businesses

Why would a business choose inventory financing? For smaller businesses, it can be a challenge to keep enough inventory to compete and even grow. A manufacturer of seasonal product may build up its inventory during the off season; financing can ease cash flow interruptions that result from the delays between production, shipment, and payment. 

Applying for Inventory Financing

The application process for inventory financing is similar to other types of financing: businesses will need to provide balance sheets, income statements, and cash flow statements. A lender will also want a list of the inventory and a sales forecast or financial planning document. Including a copy of a business plan is always a good idea, too, as are bank and tax statements.

As with any financing, if inventory financing sounds like a good option for your business, ensure you do your research and due diligence before proceeding.

 

Disclaimer: The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.