Keeping cash flow consistent and inventory stocked can be difficult for small businesses, especially during the off-season. When it comes to loans or financing as a solution for your business, the options can feel overwhelming and, at times, unattainable. One often-overlooked option is inventory financing. Inventory financing can be great for businesses looking for a flexible loan option. Read more to find out if inventory financing is right for you and your business needs.
What is Inventory Financing?
Inventory financing is a line of credit or short-term loan that companies use to purchase inventory now and sell it later. The products or inventory are then used as collateral, meaning you won’t need to pledge other assets. Inventory financing is used to help businesses and wholesalers during slow seasons when there is little cash flow, and allows them to prepare for busier seasons that may include high-volume orders. Some reasons why businesses choose inventory financing are:
- Maintaining steady cash flow throughout the year
- Stocking up and preparing for busier seasons
- Buying more inventory as customer demand increases
- Updating products
How Does Inventory Financing Work?
Inventory financing is a type of asset-based lending. Businesses will utilize inventory financing loans to stock up on inputs and materials needed to create the final product. The inventory itself will act as collateral to the loan. If your business cannot pay off the debt, the lender will seize the remaining inventory and sell it to cover the loss. Many lenders will offer a percentage of the total cost of the inventory as the loan. This percentage will vary depending on the inventory resale value and the lender.
Types of Inventory Financing Loans
There are two main types of inventory financing to choose from:
Inventory Loans
An inventory loan provides the entire loan amount upfront, which the business repays over a specified period with interest. This option is ideal for financing one-time large inventory purchases. Consider the repayment period and how long it will take to sell your inventory for a profit when choosing this type of financing.
Inventory Lines of Credit
An inventory line of credit gives your business access to a credit limit to draw upon as needed. You repay it monthly and only pay interest on the borrowed amount. Since the credit is revolving, once the debt is repaid, you can borrow up to the maximum approved amount again. Businesses that consistently purchase inventory should consider this type of financing.
Pros and Cons of Inventory Financing
When deciding whether or not you should invest in inventory financing, you want to have a clear understanding of the pros and cons.
Pros
Self-collateralizing: Because your inventory is acting as your collateral, other elements may not be the main factor in qualifying for the loan. Business owners won’t have to put up other assets to acquire the loan. Things like how long your business has been in operation or your personal credit score may not be considered since your inventory is being pledged, making inventory financing more accessible to smaller or newer businesses.
Simpler applications: Inventory financing offers a simpler application than traditional business loans. Many business loans take a great deal of time and resources to acquire. Since the requirements for inventory financing are more lenient, it is easier to apply and get your loan faster. As long as you are structured and organized with your inventory, the application process should be straightforward.
Extended sales period: With inventory financing, businesses can sell more products over a longer period of time. They are able to prepare for busier seasons, update their products, and maintain a steady cash flow even in the slower months.
Cons
Like any commitment, you will want to consider the potential disadvantages that could come along with it. Inventory financing is no exception.
Partial coverage: Depending on the lender, you will likely only receive a percentage of the total cost of inventory. This might make it harder to prepare or secure all the products that your business may need.
Higher interest rates: Since the inventory serves as the collateral for the loan, the risk associated with the financing may be higher than other forms of lending. This can mean higher interest rates which leads to a more expensive loan repayment. For new businesses or businesses with pre-existing debt, inventory financing may make it harder to run operations smoothly as you repay your loan, making other lending alternatives more appealing.
How to Acquire Inventory Financing
Once you have decided to pursue inventory financing for your business needs, you will need to follow the proper steps to apply for the loan.
Ensure You and Your Business are Eligible
Make sure that you and your business qualify for inventory financing. The requirements will vary depending on the lender, but here are a couple of key differences to look out for:
Business operation duration: Different lenders have varying requirements for how long a business must be in operation. Since the inventory purchased is what is used as collateral, many institutions have slightly less rigid conditions for your business history when applying for inventory financing. Some lenders will offer loans to new businesses after 6 months, others require at least a year or more. The longer you have been in business, the more likely you are to be approved.
Credit score: Although it is possible to be accepted for inventory financing with a lower credit score, it is recommended that you have a higher credit score. This can increase your chances of being approved as it highlights your ability to pay back debt.
Compare Different Lenders
When deciding on where to apply for inventory financing, it is important to consider all your options. Look at things like their requirements for application and approval, the average borrowing amount offered, and the different interest rates offered. Prioritize an institution that has experience working within your specific industry.
Obtain All Necessary Business Documents
The documents needed will vary depending on the lender and their requirements. Commonly requested documents for inventory financing include:
- Inventory List: An inventory list will showcase what inventory you currently have and an estimate of the resale value. Lenders need to know this information in the event of default and reselling your inventory.
- Business Bank Statements: A business bank statement will provide a summary of your transactions within a certain time period. The exact period of time to cover will depend on the length of the loan you are applying for. Lenders may need to confirm with your bank that the statements belong to you and verify the income source.
- Balance Sheets: Balance sheets will likely be requested to better understand your company’s financial position.
- Profit and Loss Statements: A profit and loss statement (also referred to as an income statement, statement of operations, or statement of earnings) will outline your business’s profits, costs, and expenses during an allotted period of time. This will help the lender understand your business’s net income. Lenders will need to determine if you have the potential earnings and resources to repay the debt.
- Business Tax Returns: To further verify your revenue and earnings, you may need to provide your business tax returns to the lender for inventory financing.
- Future Sales Forecast: Future sales forecasts/projections will help the lender understand your potential for profit and ability to repay your debt.
Apply For Your Loan
Once you have established your eligibility, decided on a lending institution, and acquired all the necessary documentation, you are ready to apply for inventory financing. Be sure to read through and understand the terms and conditions of your contract. Once you have been approved and signed your contract, you should receive your inventory financing loan within a few business days, but this also varies depending on the lender.
Inventory Financing Alternatives
Inventory financing has a lot of advantages; however, it may not be the best option for your business. Here are a few other options that can help increase working capital so you can keep your business operating.
Invoice Factoring
Invoice factoring is the process of selling your business’s unpaid invoices to a factoring company or bank in exchange for a cash advance while waiting for your customers to pay. The factor collects the customer payment for you, typically keeping a portion as a fee for the service. This helps resolve issues with delayed payments, increases working capital, and also allows you to invest your capital into growth opportunities. Factoring is a great solution if one of your biggest assets is your accounts receivable, and the capital unlocked can be utilized anywhere in your business operations.
Asset-Based Lending
Asset-based lending (ABL) is a type of financing where business assets—such as accounts receivable, equipment, and inventory—are used as collateral against the loan. Like inventory financing, ABL can take the form of a revolving loan or line of credit. While inventory financing secures the inventory against the loan, asset-based lending allows for a broader selection of collateral.
Purchase Order Financing
Purchase order financing is very similar to inventory financing. Your company receives a loan to pay for your products. The main difference between the two is that purchase order financing is specific to your purchase orders instead of your inventory as a whole.
SBA Loans
An SBA (Small Business Association) loan is guaranteed by the U.S. Small Business Association. This loan can cover many different expenses for your business, including your inventory. The interest rates on the loans are determined by the Federal Reserve. However, due to it being a governmental loan, the application process can be tedious and it may take a while to receive the loan.
Business Term Loans
Traditional business term loans are another alternative to inventory financing and SBA loans. These loans are set over a period of time and can pay for a lot of different business costs. Unlike the SBA loan, you can receive the money much sooner. Since it is a cash flow-based loan, you will not be required to leverage your assets, which is helpful if you don’t have available collateral to put up.
Discover the Perfect Loan for Your Business
Looking for the right loan to grow your business? TAB Bank offers a wide range of financing options tailored to your unique needs. Whether you need asset-based lending, invoice factoring, or lines of credit, TAB Bank is here to help you succeed. Check out our commercial lending guide to explore your options and find the perfect fit for your business today!
