Inventory Financing

As a small business owner, you know that cash flow fluctuates. A flush month can make up for a slow one, but a slow one can make it tricky to cover expenses. Savvy business people know that there are a number of asset-based lending options that can help cover a slump and make sure you have working capital to keep running.

For businesses that sell products, one of those ways is known as inventory financing. Inventory financing is a business line of credit that allows you to purchase inventory on credit, then pay back the principal amount when your products sell.

You’ll pay monthly interest on your line of credit, like you would with a credit card, but inventory loans allow you to not only support your supply chain, but also finance larger amounts and pay different kinds of bills, like rent and payroll.

How Do You Finance Inventory?

Financing inventory often comes as a part of a business loan package offered by your bank. The inventory the loan will pay for serves as collateral against the loan.

An inventory finance loan allows you to purchase your product, or materials to create your product, before it is sold. This kind of financing is especially useful for newer businesses that don’t have large amounts of cash on hand but that do have, or will have, a large contract or purchase order to put a product in a major retailer, like a Target or Wal-mart.

When your product is manufactured and then ships and the retailer pays your company, you can pay back your line of credit.

Can Inventory Be Used As Collateral?

The idea behind this kind of asset-based lending is that the raw materials needed for your product have value, and if you, as the borrower, were to default on your loan, the bank would be able to sell the materials and not lose their money.

For this reason, you usually can’t get this form of asset based financing for 100% of the amount you need to buy raw materials, but for a portion of the cost of the materials.

How Does Inventory Financing Work?

Inventory financing is a credit line specifically designed for businesses that sell a product. You take out the line of credit to pay for materials or supplies for your product and when your product sells, you repay the loan.

The raw materials act as collateral, or security, against the financing.

How to Apply For an Inventory Financing Loan

To apply for inventory financing, you’ll need to make sure your business fits a few criteria. The first is, of course, it must be product-based. You wouldn’t need this type of financing if it wasn’t.

The second is that typically, you’ll need to have been in business for at least a year. Lenders will want to see that you have some business history and have a look at your financial records before extending a line of credit.

Lenders will also want to know what kind of inventory you’ll be financing. Perishable items, like food, will be eligible for less financing than other kinds of inventory.

Once you’ve determined that this kind of financing makes sense for your business’ inventory management, you’ll go through a process of financial review with your lender and find out if your business is eligible to borrow, how much of a loan you might be able to take, and at what rate you’ll need to pay interest.

Keep in mind that inventory financing can be very expensive.

How To Get The Best Inventory Financing Loans

Like with other forms of financing, you’ll want to put your best business foot forward when applying for a loan.

You’ll want to make sure you have good business credit and solid documentation, including a business plan, profit and loss statements, sales forecasts, tax returns and information about the inventory you need to finance.

Information about any orders or expected orders can also be important, as this type of financing can be a rigorous process that takes a few weeks, or even months, to secure.

Inventory Financing vs Accounts Receivable Factoring

Inventory financing, invoice factoring and accounts receivable financing can sometimes be confused. Invoice factoring and accounts receivable financing are terms that refer to the same product -- a loan or form of business financing based on outstanding invoices owed to your business.

The two are also similar in that they can act like a line of credit, with funds being taken out and paid back in a revolving plan, as needed.

Inventory financing, sometimes called inventory factoring, on the other hand, is not based on outstanding bills due to your company, but on the value of the inventory you’ll eventually sell.

Inventory factoring in particular refers to the idea of getting a loan to finance the purchase of materials needed for a large corporate order. For example, if your business gets a contract to sell a home product to a large retailer, like Bed, Bath and Beyond, you may be able to get a loan to pay for materials based on the value of that contract.

In the end, a strong partnership with a lender will help you find the best kind of financing to keep your cash flowing and your business running smoothly.