Wednesday, April 27, 2016

What Your Business Needs to Know About Inventory Financing

If you run a small retail or wholesale business, you know that maintaining your inventory—and the right amount of the right kind of inventory—is crucial to your success. To keep making sales, customers need to know that you’ll have the products they want and need available whenever they shop.

But as with any business, cash flow can get tight from time to time for retail or wholesale businesses. Maybe you lost some inventory that got spoiled or damaged, or customers weren’t as keen on a particular product as you hoped they would be. When that happens, how are you supposed to continue buying inventory in order to make more sales and improve your business’s financials?

While there are lots of business loan options available—including traditional term loans, short-term loans, and business lines of credit—for the specific scenario of a retail or wholesale business in need of financing to purchase stock or raw materials for inventory, often inventory financing is the best and most accessible option.

What is Inventory Financing?

Inventory financing is a debt-based funding solution—typically in the form of a line of credit, term loan, or short-term loan—that’s made to a company for the express purpose of purchasing products for sale. It works similarly to equipment financing: the inventory itself serves as collateral on the loan.

As long as you make payments on time, that inventory is yours to work with as you see fit. But if you were to fail to make payments or default on your loan, your lender would have the right to repossess your inventory (or other inventory of similar value) as repayment for your debt.

Inventory Financing and Collateral

The risk of signing away your family home or personal assets in the event your business fails is beyond intimidating—especially if you’re in a risky industry or reeling from short-term financial challenges. And even with the fear factor aside, some business owners just plain don’t have the sort of personal capital required to qualify as sufficient collateral for their loans.

Regardless, most business lenders require borrowers to offer some form of collateral or personal guarantee. That’s why the ability to use the inventory itself as collateral through inventory financing is such a major perk for borrowers. Lots of business owners who choose inventory financing over other business loan products do so to take advantage of this alternative form of collateral.

Are You a Good Candidate for Inventory Financing?

Now that you understand what inventory financing is, how do you know whether your business is a good fit? Answer these questions to help you decide whether inventory financing will work for you.

Is Your Business Product-Based?

Obviously this type of financing is based on inventory, so service-based businesses—whose sales are based on work performed, not inventory sold—need not apply. Businesses in the retail, wholesale, manufacturing, or distribution sectors can be good candidates for inventory financing.

Has Your Business Been Around For at Least a Year?

Because of the need to review past financials and inventory records, this type of financing isn’t available to brand new startup businesses. Your business will need to have been operational for at least one fiscal year, and ideally three or more, in order to qualify for inventory financing.

Do You Meet the Minimum Borrowing Requirements?

Because of the extra time, paperwork, and due diligence involved in the underwriting process for inventory loans or lines of credit, some lenders have a minimum borrowing requirement for inventory financing that’s significantly higher than for other loan products—in some cases as much as $500,000 for a minimum principal amount.

Depending on the size of your business, this might be significantly more assistance than you need—or than your inventory’s value can support. Before deciding whether inventory financing is the right fit for your business, talk to your individual lender to discuss their minimum requirements for inventory financing and whether your borrowing needs will fit within that requirement.

Have You Kept Good Inventory and Financial Records?

In order to approve your inventory financing loan or line of credit, your lender will want to review the history of your business’s inventory and finances. They’ll take a look at your past sales volumes, inventory turnover rate, any loss or damage to your past inventory, and the gross profit margins of your past inventory sales.

If you’ve kept detailed records using an accounting software or inventory management system, compiling this data could be no big deal. But if you haven’t kept diligent records or don’t have this information available, you might have a hard time finding a lender to approve inventory financing for your business.

Can You Wait to Undergo the Due Diligence Process?

Depending on the lender, your credit score, the size of your loan, and your business’s financial history, you could have to undergo an extensive due diligence process before qualifying for inventory financing. Along with reviewing your business’s inventory management and financial records, the lender might even send a third-party auditor to survey your inventory in person.

These steps can take up a whole lot of time, causing the inventory financing process to last weeks or even months before you have cash in hand. If you’re strapped for time to get funding, inventory financing might not be your best option.

Weighing the Pros and Cons

Even if your business qualifies for inventory financing, there are plenty of reasons that this financing option may or may not be the right fit. As with anything in business, along with the perks of this borrowing option come a fair number of restrictions or drawbacks you’ll want to consider.

Take a look at these pros and cons to help you determine whether you’d like to pursue inventory financing for your business.

Pro: Achieve a Higher Sales Volume

Inventory financing is most effective for small- to medium-sized businesses who use it strategically. Typically, these businesses have recently been through a season in which their product stock sold out quickly and demand strongly outpaced their supply. They know that they could sell more inventory if they had the volume available, but they don’t have the cash on hand to purchase or manufacture the inventory for sale.

In these cases, inventory financing is a fantastic opportunity to boost the amount of inventory your business can purchase or manufacture, and then quickly repay your loan through the proceeds of your higher sales volume.

Con: Can Be Difficult to Secure

That being said, while inventory financing is in many cases more accessible than traditional bank loans, it’s by no means the easiest form of debt financing to secure. The goal of inventory financing is for the inventory itself to be used as collateral.

But the reality is: if you as a business aren’t able to sell your inventory, chances are the lender won’t be able to sell it either, at least without a significant discount. Knowing this, some lenders are hesitant to approve loans or lines of credit that use inventory as collateral.

Pro: Avoid Putting Up Home or Personal Property as Collateral

Because the inventory itself acts as collateral on the loan, inventory financing can save small business owners from the risky step of offering their own home or property as collateral on the loan, or signing a personal guarantee.

Business owners who are wary of tying too much of their personal finances to the success or failure of their business—or those who don’t own a home to offer as collateral—are more likely to see inventory financing as a valuable option.

Con: Might Have Higher Interest Rates Than Other Loan Options

Keep in mind that the perks of avoiding collateral or a personal guarantee can come with a steep cost. Because inventory financing is typically considered less secure than a more traditional loan product, lenders often make up for that added risk in the form of higher interest rates.

If you’re shopping between an inventory financing loan or line of credit and a more typical loan product, be sure to compare the interest rates and APRs to make sure that the benefits of inventory financing would still be worthwhile.

Pro: Helps Seasonal Businesses Prepare for Busy Months

For seasonal businesses, acquiring the necessary inventory to prepare for “high season” after a long period of low sales can be cost prohibitive. Having gone several months without doing much business, it’s understandable that these businesses might not have the cash on hand to make a big inventory purchase. Inventory financing can fill the gap for seasonal businesses by letting them acquire extra inventory to sell during their busiest seasons.

Con: Due Diligence Can Be Lengthy and Expensive

Perhaps the biggest challenge to inventory financing as a funding solution is the potential length and expense of the approval process. Unfortunately, business owners often look into inventory financing when they actually needed cash in hand, well, yesterday.

Not to mention, the process of meeting with an auditor and compiling records can in itself be time consuming and expensive. If you can’t commit to this more intensive application and underwriting process, inventory financing might not be your best fit.

Pro: Helps Keep Shelves Stocked with Merchandise

Ultimately, all of the pros and cons surrounding inventory financing come down to this final point. Do you need a little boost to keep your shelves stocked with merchandise—and do you believe that the resulting sales will be valuable enough to pay back the loan and provide additional value to your company?

If the answer is yes, there’s a good chance that the benefits of inventory financing will outweigh the challenges.

How to Apply for Inventory Financing

If you’ve gotten this far and still believe inventory financing could be the perfect fit for your business, you’re probably wondering, “Well, how do I apply?”

Compared with more traditional lending options, the application process for inventory financing can be much more lengthy and involved. The approval process can take months, requiring extensive amounts of paperwork, interviews, and even an in-person audit of the company’s assets and financials.

If you’re willing to be patient and you believe that inventory financing is the best way to fund your business, here are the steps you’ll want to follow to set your business up for success:

1. Get a Firm Handle on Your Business Financials

Before you begin the process of working directly with an inventory financing lender, you’ll want to get a firm grasp on your company’s financial standing. To do this, you need to not only compile, but also comb through, the ins and outs of your financial documents to be sure you understand your assets, debts, profits and losses, and the future projections of your business growth.

As a starting point, gather and review the following financial documents, as these will likely be requested by any small business lender as part of the application process.

Balance Sheets – Most brokers recommend having accurate balance sheets on hand, both for your business’s year-to-date operations and for the two prior fiscal years. If you use accounting software like Quickbooks, you should be able to pull your balance sheets easily—or use our free balance sheet template to create your own.

Profit & Loss Statements – This document shows your company’s revenue and expenses. Include a year-to-date P&L updated within the last 60 days, as well as total profit and loss statements for the last two years.

Sales Forecast – Inventory financing lenders tend to be more focused on the future of your business rather than its history. If you have a well-researched sales forecast that shows a strong trajectory of growth, that document may help to tip the scales in your favor.

Personal Tax Return – Especially if you have a relatively new business, lenders might ask to see your most recent tax return.

Business Tax Returns – If you’ve been in business for awhile, have your last 2 – 3 years’ business tax returns on hand to show your long-term revenue history.

Business Banking Statements – Provide at least 4 months’ worth of banking statements, 6 if you have them, and 12 if your business is seasonal. For each month, remember to include all pages of the bank statements, not just the first.

Inventory List – Compile a list of the inventory you already have on hand, where it’s stored, and its approximate resale value. Keep in mind that if your inventory were to be liquidated in the event of a default, your lender would probably have to sell the merchandise at a lower price than your customers would ordinarily pay, so the resale value will be lower than the product’s wholesale or retail value.

Inventory Management Records – The value of your inventory financing loan or line of credit will be based not only on the stock you already have on hand, but also the inventory you plan to purchase with the funding. Accordingly, your lender will be interested in your rate of turnover for past inventory, what percentage of your inventory went unsold due to loss or damage, and your profit margins on past inventory.

2. Complete Initial Application and Submit Financial Documentation

If you’ve followed the steps above to gather the necessary documentation for your business financials and inventory, the actual application process—while still more complex than with traditional lenders—will be much simpler.

Complete your lender’s online application and submit the necessary financial paperwork electronically. Some lenders might require you to have your financials audited by a third-party agency before your application can be processed, so check directly with your lender to clarify their specific requirements.

If the lender considers you a strong candidate for inventory financing, you’ll be contacted to enter the due diligence period of the application process.

3. Review Offer and Commit to Due Diligence Period

Because of the amount of work a lender has to put in on completing due diligence for inventory financing, many lenders will ask for a preliminary commitment in order to mitigate the risk of performing due diligence on behalf of a borrower who does not follow through.

After completing an initial review of your application and financials, the lender will present a preliminary offer detailing the loan or line of credit amount, interest rate, and terms they may be be able to provide.

This offer is meant to be a preview of what the lender believes it will be able to offer in order to gauge your continued interest, but it’s not a final offer and is non-binding both for you and for the lender. If you’re interested in the lender’s preliminary offer, they might ask you to pay a due diligence fee as a commitment of your intention to proceed with the loan.

4. Undergo a Field Audit of Your Business

As part of the due diligence process, your lender asks to conduct a field audit of your business. During the audit, a representative would meet with you in person to gauge whether there’s a good fit between you and the lender, visit your office space, and examine any inventory that you currently have on hand.

5. Await Final Approval and Funding

By the end of your audit meeting, you’ll probably have a strong sense of your relationship with your lender and whether you’re likely to be approved for inventory financing. At that point, all you can do is wait for the lender’s final decision before you receive funding. There’ll likely be some paperwork to sign, but once all the documentation is executed, you should have cash in hand within just a few days!

Inventory Financing Alternatives

While inventory financing is a perfect fit for some businesses, others could be intimidated by the potential hassle of undergoing additional due diligence for a short-term loan or line of credit.

If the added complications of inventory financing seem like more than your business can take on, check out the alternative small business borrowing options that might be a better match for your business needs.

Traditional Term Loan

You’re likely already familiar with traditional term loans—they’re what most people naturally think of when they think of a business loan. You borrow a fixed amount of money, usually for a specifically stated business purpose, and pay back the loan over a fixed term and typically at a set interest rate.

If you’re looking to borrow a set amount of capital to be used for a wide range of business purposes and pay it back over a year or more through predictable monthly payments, a term loan will likely be your first and most obvious choice.

Short-Term Loan

Some business owners start looking into inventory financing when what they really need is quick access to cash to cover their next inventory purchase or take advantage of a good deal. But because of the longer due diligence period typically involved with inventory financing, that often doesn’t turn out to be the best option for their business.

Instead, consider a short-term loan that can be paid off in daily or weekly payments within the 3 to 18 months. Many online lenders can approve short term loans within 24 hours, providing you with cash in hand in as little as two business days.

Business Line of Credit

Perhaps the most flexible form of business funding available, a business line of credit gives you capital to draw upon to meet a variety of business needs. Once established, you can draw on your line of credit as you would a personal credit card to get more working capital, handle seasonal cash flows, pay off other debts—and, of course, purchase inventory.

Unlike with an inventory line of credit, most traditional business lines of credit require some form of outside collateral. But the lower interest rates and relative simplicity of qualifying might be worth this extra step.


As more and more financing options become available to small business owners, there are a lot of factors to consider as you choose the right loan product for your business. And if you’re not sure which direction to go, we’re here to help!

The post What Your Business Needs to Know About Inventory Financing appeared first on Fundera Ledger.

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