Cash flow is a challenge for small businesses, especially for those that have to carry large inventories. Inventory keeps your business running but it locks up capital. If you need to stock up on inventory but are running out of cash, inventory financing could meet your needs.
How Does Inventory Financing Work?
Inventory financing allows small businesses to borrow money and buy inventory. The financing can take the form of a short-term loan or a revolving line of credit. Inventory in your warehouses secures the loan.
Inventory financing helps businesses secure cash to buy inventory stock ahead of seasonal demand. These businesses can use all or some of their inventory as collateral on the loan. If the business fails to pay back the loan, the financing company will seize the collateral.
How Do You Qualify for Inventory Financing?
To qualify for inventory financing, you need valuable inventory with high potential. If you can’t sell your inventory, a lender won’t want it because of the risk that the value drops.
First, start with a list of the inventory you want to use as collateral. You will also have to provide the value along with the valuation method (LIFO, FIFO, or average cost). The lender will want a business plan that shows how you plan to use the money and your plans for repayment.
You have a duty to keep the inventory in good condition over the term of the loan. The financing company has the right to check the inventory at any time.
What Companies Can Benefit from Inventory Financing?
Smaller companies benefit from inventory financing. Many of them lack the assets required to finance larger loans through traditional banks. Retailers, wholesalers, and online stores traditionally use inventory financing.
These short-term loans help you grow your business. Use the funding to free capital and buy new product lines, take advantage of discounts, and prepare for seasonal sales.
How Is Inventory Financing Calculated?
You will have to provide a list of your inventory, along with the value. After the lender has done the due diligence, you will receive somewhere between 20% and 80% of the inventory value if the funds are approved.
How Much Does It Cost to Finance Inventory?
Interest rates on inventory finance are usually several percentage points above the prime lending rate. The overall cost will depend on the term of the loan, the size of the loan, payment terms, and the agreed interest rate.
Types of Inventory Financing
There are two types of inventory financing that you can choose from, an inventory loan or an inventory line of credit.
Inventory Loan
An inventory loan operates like any other secured loan. It is for a set amount over an agreed period. You make repayments at agreed intervals over the term. Alternatively, you may pay a lump sum at the end of the term after you have sold the inventory.
Line of Credit
Many businesses prefer a flexible line of credit. With a line of credit, the finance company approves a loan amount. You can borrow as much as you want up to the limit and continue borrowing as you make repayments. You only pay interest on the amount you owe.
Things to Consider When Choosing Inventory Financing
There are several important factors that you should consider before choosing inventory finance, let’s take a closer look.
Determine If Inventory Financing is Right for Your Business
Inventory financing is a short-term funding option with a specific purpose – to fund inventory. If you need funds for other uses then a business loan may serve you better.
Costs of Financing Inventory
Inventory financing is expensive so it is vital that you weigh the costs against the benefits to your business. You must ensure that you still make healthy profits after paying back the inventory finance with costs.
Limitations of Inventory Financing
If you don’t have valuable inventory or if you need funds for business objectives other than inventory replenishment, you will have to find another source of funds.
Advantages of Inventory Financing
There are several good reasons to consider inventory financing
- Good for businesses where the finances or credit rating won’t qualify for traditional loans
- Improve your cashflow – unlock the capital invested in inventory and use it to grow your business
- Prepare for the peak season – use inventory finance to build stock for your seasonal high so you don’t lose out on sales
- Add new product lines or equipment – use the money to grow your business
- Take advantage of discounts
- Quick access to funds
Disadvantages of Inventory Financing
Before you settle for inventory financing, you must weigh the disadvantages
- Interest rates can be high
- Working out the inventory value can take time and money
- Funds are only for inventory – you can’t use these funds for anything else. Business loans are a lot more flexible. Use business loans to finance items like fleet management systems or telematics
- The lender can check your inventory and sales at any time over the term of the loan.
Inventory Financing vs. Accounts Receivable Financing
The main difference between inventory financing and accounts receivable financing is lender risk. Inventory depreciates over time. The value of your invoices remains unchanged.
Ensure an Accounts Receivable process that runs like clockwork using an automated invoicing system that has a built-in pay button for quick and easy payment.
Unlock capital with inventory financing
If you have a warehouse full of inventory and you need cash to buy more, inventory financing might be for you. It could help you grow your business but it is expensive and you should balance the costs and benefits.
If you’re using inventory financing because you don’t qualify for a loan from the traditional banking system, consider TAFS for longer-term loans. TAFS will tailor a trucking business loan to the needs of your business and help your business grow!
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