Inventory financing is a type of asset-based lending that allows businesses to borrow capital using inventory as collateral. Business owners can use the inventory they already have or the products they intend to buy as collateral. It’s a type of loan that’s generally used by e-commerce and brick-and-mortar retailers, wholesalers, and restaurants.
Borrowers can access inventory financing as a short-term loan or revolving line of credit. Either way, it’s helpful for companies that carry a large amount of inventory and require cash to buy more inventory or cover other operating expenses.
Keep reading to find out more about inventory financing and how you can use it to run and grow your business.
What Is Inventory?
Inventory refers to products and merchandise that companies have available for sale. The definition also includes the raw materials used to produce goods.
That’s why having enough inventory is important to keep operations running smoothly. It’s easier for businesses to meet expected or unexpected increases in customer demand when they have the products available on hand. It can also save companies money to buy inventory in bulk. And in cases of shipping or production delays, companies still have enough supply to sell until operations go back to normal.
How Is Inventory Financing Used?
As mentioned, businesses typically have large amounts of inventory to keep operations running smoothly. But this puts them at a disadvantage because it ties up their capital until the products are sold. This is where inventory financing comes in: It allows companies to leverage their inventory to acquire much-needed cash.
Small-business owners typically use inventory financing to purchase additional inventory. But they can also use funds acquired from this type of financing for other business expenses. For instance, cash from inventory loans can help businesses cover cash flow gaps, especially during seasonal fluctuations when sales are low.
Many businesses buy their inventory in bulk at a discount to save money. They also stock up to prepare for an incoming busy season so they don’t miss out on sales.
At times, it’s also necessary to buy more inventory to meet an increase in customer demand. Companies may also need capital to bring in new products to refresh or update their current offerings.
This is why inventory financing is a useful funding option for product-based businesses. It’s also a great loan option for startups and new businesses because eligibility requirements aren’t as strict as traditional financing.
With inventory financing, many lenders only require six months to a year for the minimum time in business. And some lenders accept lower personal credit scores since inventory financing is considered a secured loan.
However, it’s important to note that inventory financing is different from other small business loans.
Liquidation value: Since inventory can depreciate or lose its value over time, lenders don’t give you a loan equal to the selling price of your merchandise. Instead, lenders request a professional appraisal to determine the liquidation value of your asset. Then, they use that valuation for your loan. However, the amount you can borrow depends on the lender. For example, one lender may offer you a loan for 70% of the liquidation value, and another may offer 80%.
Due diligence: Similar to other funding options, lenders look at your creditworthiness, time in business, and revenue. But inventory loans have a few extra steps before approval. Lenders also review your inventory records (since your inventory secures the loan), and your ability to pay your loan depends on how fast you sell your merchandise. So, the lender may have a third-party review and audit your finances and inventory management system.
Cost of borrowing: Depending on your credit history, inventory financing could be expensive if you don’t qualify for a lower interest rate. So, it’s important to ensure your profits can cover the fees and interest for the capital you’re borrowing. Also, consider if your business cash flow can cover your weekly or monthly payments.
An Example of Financing Used to Purchase Inventory
Interest rates, repayment terms, and conditions vary from lender to lender, but here’s an example of how businesses use inventory financing loans.
Let’s say you’re a business owner with a party supplies store and you’re anticipating a significant increase in sales due to the approaching holiday season. You’ll need cash to buy more inventory and hire additional salespeople.
You’ve calculated the amount you’ll need to be around $100,000 to prepare your business for the incoming busy season. You found a lender and applied for financing.
The lender determines that the liquidation value of your inventory is $80,000 and offers you a loan for 80% of that amount. Then, you draft a loan agreement of 8% interest with a repayment term of 12 monthly payments.
2 Types of Inventory Financing
There are two main ways to access inventory financing. You can get it as a short-term loan or line of credit. Your inventory works as collateral to secure both types of inventory financing. But interest rates and repayment terms depend on your lender, industry, and type of inventory.
Also called a short-term loan, an inventory loan provides borrowers with a lump sum amount upfront based on the value of the company’s inventory. Then, the borrower repays the loan plus interest through a fixed amount over an agreed-on repayment schedule. The repayment period for inventory loans typically ranges from six to 36 months.
A short-term loan could be the right option for you if you just need a one-time loan. Check out the short-term loans you can get through Clarify Capital. The loan application process is easy and quick. You can fill out the form in two minutes.
Inventory Line of Credit
When you get approved for an inventory line of credit, you get an account with a set credit limit. A business line of credit could be a valuable financing option if you need flexibility with your borrowing. You only pay interest for the amount you use, and you have access to cash that you can withdraw and repay as often as you need. Just make sure you don’t exceed your credit limit.
With a revolving line of credit, your loan replenishes as you pay it off (so you don’t need to apply for another loan if needed). It’s also an excellent way to build your credit rating.
Let Clarify Capital help you find the best funding option for your business. Call us today and speak to an advisor.
Pros and Cons of Inventory Financing
Like most loans, there are pros and cons to inventory financing. We recommend shopping around or asking for help from professionals like Clarify Capital so you can choose the loan option that addresses your specific business needs.
Pros of inventory loans:
Additional capital increases a company’s ability to meet customer demand, make more sales, and grow the business.
Inventory loans help business owners take advantage of discounts from buying in bulk and allow businesses to stock up for the busy season.
Since the loans are secured by inventory, businesses don’t need to present other personal or business assets for collateral.
Personal credit score and other indicators of creditworthiness aren’t the main criteria for loan approval, so it’s easier for business owners with poor credit to get a loan.
They help new businesses access credit because lenders only require a minimum of six months to a year of operations to get approved.
They’re easier to apply and qualify for than traditional bank loans.
Cons of inventory loans:
Lenders only approve loans for a percentage of the value of the inventory, which means the borrower may not get all the cash they need.
It can be difficult for businesses to pay the higher interest rates and fees of inventory loans.
It may take time for the financing lender to complete their due diligence and delay the loan.
Lenders may want a professional to check the inventory, and the borrower would be responsible for paying the appraisal fee.
Creditors may have specific rules the borrower has to comply with, such as taking out insurance on the inventory or using the funds for buying inventory only.
Some lenders may ask for a general lien on the borrower’s assets, which means they can have a claim to any and all of the business owner’s assets in case of a default.
When Should You Use Inventory Financing?
Inventory financing might be the right funding option for your business if you’re a retailer, a wholesaler, or a company that relies heavily on having enough inventory at all times. This type of small-business financing is also very useful if you’re a new business. And it’s a great alternative loan for business owners with no credit history or business assets to put up for collateral.
Inventory loans are also great for companies with strong sales records. If you have an excellent inventory management system and know you can profit from acquiring additional inventory, inventory financing could pay off for you.
Before applying for any kind of loan, though, consider how much you need and what kind of repayment terms you can afford. Then, shop around for loans or talk to a Clarify advisor. Our dedicated advisors can help you choose and apply for the best loan option based on your business needs.
How to Secure Inventory Financing
Most financial institutions, such as banks and credit unions, offer inventory financing. You may also apply through online lenders. As you can imagine, the requirements, interest rates, and conditions vary based on the lender.
At Clarify Capital, we work with more than 75 lenders to get you the best rates. Here are the three main criteria they want to see:
Time in business: Financing companies use your time in business to gauge their risk in lending to you. So, the longer you’ve been in operation, the less risky you are. It also means your business is more established and you can repay your loan. To qualify for all the loans we offer, we recommend that your business has been operating for at least six months.
Credit history: Your personal credit score represents your creditworthiness and how responsible you were with your credit in the past. When it comes to your credit score, higher is better. You can then qualify for lower interest rates and better repayment terms. Even so, Clarify works with all business owners regardless of credit, and we recommend a minimum score of 550.
Business revenue: Lenders want to see how your finances are doing because they want to know you can repay your loan. To get approved for loans, we recommend having at least $10,000 in monthly revenue.
Business plan: A good business plan provides a blueprint for your company. It guides you through each stage as you grow. If you don’t have one, check out the SBA’s business plan templates and put your plan to paper in case creditors ask for it.
Your company’s financial statements: Lenders typically want to see your company’s financial statements, such as cash flow statements, balance sheets, and profit and loss statements (P&L statements) to gauge your sales history and inventory turnover.
Bank statements and tax returns: Lenders may also want to know about your personal assets and any other loans you may have. They may ask for three months’ worth of statements from both your personal and business accounts. Also, have your business and personal tax returns for at least the previous two tax years.
Inventory records: Lenders may ask to see a value estimate for the inventory you have on hand. They may also ask for an inventory management system audit to see how quickly you can sell your merchandise.
Apply for Inventory Financing
Having the right amount of inventory means happy customers, an increase in sales, and growth for a business. But carrying inventory ties up your capital. Why not leverage it so you can cover other business expenses?
Fill out our application form or talk to a Clarify advisor today to explore how we can help you get inventory financing. Get the best rates and lower your borrowing cost with Clarify!