How Inventory Financing Works & When It’s Right (Or Wrong) For Your Small Business Funding Needs
You need to buy inventory for your company, but you don’t have enough capital to do so. Conventional financing is not a viable option for your business, but you know you can quickly sell the inventory you want to purchase. Is there a way to leverage your inventory and use that as collateral? What other options are available to you? Read on to learn about inventory financing and whether it’s a good fit for your business.
Table of Contents
- What Inventory Financing Is & How It Works
- Types Of Inventory Financing
- Expected Rates & Terms For Inventory Financing
- When Inventory Financing Is A Good Choice For Your Business Funding Needs
- When To Avoid Inventory Financing
- Is Inventory Financing Right For You? How To Find An Inventory Financing Company
- Don’t Think Inventory Financing Is Right? Learn About Other Types Of Small Business Financing
What Inventory Financing Is & How It Works
Inventory financing is a type of asset-based loan in which the inventory you’re purchasing with the loan is used as collateral to secure the loan. Depending on the arrangement, the lender may also require you to put up your accounts receivable as collateral. The amount of financing you receive is directly related to the value of the inventory in question, usually 70 to 80% of the inventory’s value. As you sell the inventory you purchase with the loan proceeds, you’ll be able to repay the loan.
Inventory financing is typically used by large upstream producers and distributors of tangible goods, such as manufacturing companies and product wholesalers. You’ll need to both carry a lot of inventory and be purchasing a large quantity of inventory to qualify for this type of financing.
Inventory financing products are sometimes conflated with “inventory loans,” which is a more general term. An inventory loan is simply a loan to purchase inventory, whereas inventory financing refers to a specific type of loan wherein the inventory purchased with the loan is used to secure the loan. A standard business loan to purchase inventory may instead require another type of specific collateral, a personal guarantee, or a general blanket lien on all of your business assets.
Unlike inventory financing, which is appropriate for large B2B businesses, other types of inventory loans can be used by small B2C businesses.
Types Of Inventory Financing
All inventory financing uses inventory as collateral, but there are still different types of financing agreements. In this section, let’s look at the types of loans used for inventory financing.
Inventory loans are typically structured as short-term loans, with the expectation that the inventory will sell quickly and pay for itself quickly. With an inventory financing loan, you will receive the entire sum up front and then repay the principal, plus interest, in installments.
Usually, the minimum loan amounts for inventory financing are on the high side, meaning the smallest loan you can take out could be $500,000 (or higher, depending on the lender). The amount you receive will be a percentage of the appraised value of the inventory you are purchasing, to account for the fact that inventory depreciates in value over time. For example, if you need to purchase inventory with a liquidation value of $800,000, the lender may lend you 80% of that, so you’ll receive a sum of $640,000.
An inventory term loan can be a good choice for large, one-time inventory purchases — if you have the opportunity to purchase a bulk amount of quick-turnaround inventory at a discount, for example. However, some loans may be easy to renew for repeat borrowing needs.
Inventory Lines Of Credit
A line of credit is a common loan structure for inventory financing and is more suitable for ongoing access to capital for inventory purchases. With an inventory-secured line of credit, the business owner receives a line of credit based on the value of their inventory, repays it as the inventory is sold, and borrows more funds as needed and the limit is replenished. The borrower only has to pay interest on the money they withdraw, plus any other associated fees.
Rather than one-time inventory purchases, an inventory line of credit can be useful for regular inventory replenishment needs due to cyclical cash flow issues, e.g., for a business that has slower sales certain times of the year.
Note that before you turn to an inventory financing lender for a line of credit, you may want to try to negotiate a line of credit with your vendors directly.
Accounts Receivable & Inventory Financing
Accounts receivable and inventory financing (ARIF) is when accounts receivable financing and inventory financing are used in conjunction. Businesses that frequently have a lot of money tied up in both invoices and inventory may be able to leverage both of these assets as collateral to secure financing.
Accounts receivable financing—also known as invoice financing—is a loan based on the value of your business’s unpaid invoices. You’ll usually get a line of credit based on the value of your receivables (invoices). Because A/R financing and inventory financing are both asset-based loans, they function similarly and may be used together to secure a loan or line of credit. As with inventory financing, with AR financing you’ll only receive 70-80% of the value of your unsold invoices; this is to account for the fact that some of those invoices may never be settled.
Invoice factoring is something slightly different, as you actually sell your unpaid invoices to a factoring company, but can also be used to leverage outstanding invoices to pay for inventory.
Purchase Order Financing
Purchase order financing can be a useful way for B2B companies to finance certain types of inventory purchases. With this type of financing, you receive an advance to buy the inventory you need to deliver on large purchase orders. PO financing works well for companies that resell finished goods and need to fulfill orders for these goods. The way this works is you receive a purchase order from a reliable (creditworthy) customer. The PO financing company will then front you the capital to pay your suppliers for the inventory needed to fulfill that order.
PO financing is similar to invoice factoring, except with PO financing you’re taking out a loan to fulfill an order; invoice factoring is a loan based on completed orders.
Expected Rates & Terms For Inventory Financing
Rates and terms for inventory financing, of course, vary depending on the lender and the type of inventory financing you’re applying for. But some things are true of inventory financing and asset-based lenders in general :
- Loan minimums are high (usually $500K+)
- You can only be approved for 70% to 80% of the assessed value of the inventory you’re purchasing
- The value of your current inventory must be at least twice the amount you’re asking to borrow
- Interest rates are typically in the high teens
- Repayment terms are short (up to 3 months)
- Time to funding may be as long as 30 days
- The lender may do an on-site inspection of your inventory and your inventory management system, and you will need to pay the associated inspection costs
- If you fail to repay the inventory loan or line of credit on time, your inventory will be repossessed
If these terms don’t sound like they would make sense for your business, you may be better served by an online inventory loan, which is more appropriate for smaller businesses.
When Inventory Financing Is A Good Choice For Your Business Funding Needs
As mentioned, inventory financing can be suitable for manufacturing and distribution companies. In some cases, it could also be suitable for large retailers. Consider whether the following applies to your business:
- You own a large company that deals with tangible goods (usually B2B)
- You need to borrow at least $500K and have at least $1 million in current inventory
- Your sales are outpacing your revenues
- You are unable to get higher credit lines from your suppliers
- You have outstanding purchase orders you need to fulfill
- You have an efficient inventory management system
- You’ve exhausted other possibilities for financing (such as a credit line with your vendor or a conventional business loan)
Compared to a standard business loan, inventory financing is more expensive but is usually easier to obtain, as long as you have a larger, established business and your inventory is selling quickly. You do not necessarily need to have good credit, but you will need to demonstrate a strong sales record that indicates you will be able to easily sell the inventory you are purchasing. You will generally be able to borrow up to 50% of the value of your current inventory.
When To Avoid Inventory Financing
If you have a newer business without a demonstrable sales history, or your current inventory is losing value and not selling, it’s unlikely that an inventory financing company would be interested in lending to you. This type of financing also isn’t suited for startups or smaller business-to-consumer companies such as independent retailers that only need to purchase $50,000 worth of inventory. In those cases, you’d be better off with an online inventory loan, such as a short-term working capital loan or business line of credit.
Even if you do qualify for inventory financing from an asset-based lender, you may still want to avoid this type of financing if there’s a chance you could qualify for a better loan, such as an SBA 7(a) loan. This is because inventory financing loans are more expensive than traditional business loans.
Is Inventory Financing Right For You? How To Find An Inventory Financing Company
So, you’ve decided that inventory financing is a good option for your business, and you need to find a reputable company to work with. Due to the large sums of money involved, the complex nature of asset-based loans, and all the due diligence involved in securing inventory financing, you will likely want to find a loan specialist who can guide you to navigate your inventory financing options and find a suitable lender for your company. There are also online loan matchmaking services such as Lendio that you may be able to use to secure inventory financing.
Don’t Think Inventory Financing Is Right? Learn About Other Types Of Small Business Financing
Perhaps you’ve realized inventory financing isn’t right for you because you run a B2C business and/or you have more modest financing needs. I’d like to point you toward some other loan resources that might be a better fit:
- 6 Small Business Loan Options For Purchasing Inventory
- Types Of Small Business Loans
- 14 Types Of Alternative Financing For Small Businesses
- The Best Small Business Loans For 2020
- SBA Loan Requirements
- Business Line of Credit Comparison
- Invoice Factoring Comparison
If you’re looking for specific lenders that could offer smaller amounts of capital to purchase inventory, BlueVine and OnDeck are a couple of our top picks in the small business space. I encourage you to read those reviews and see if their lending products could work for you. And as with invoice financing loans, you can also find other types of loans on online loan marketplaces including Lendio.
Need more help? Let me know in the comments and I’ll see if I can guide you in the right direction.