Best Inventory Financing Alternatives to Merchant Cash Advances

Sometimes there is simply no cash in the bank to purchase all the inventory, even though customers are clamoring for it. Banks and credit card companies don’t typically like to risk lending money to relatively unproven businesses. A merchant cash advance looks like your only fast money, and you are sure the goods will sell quickly.

The real question, though, is what other sources of capital can you find where the loan can be secured by the inventory you are trying to purchase. The stock itself could even work, depending on who your lenders are and how you put together the deal.

Inventory financing is an asset-based loan, with the goods you buy as the collateral. You may also be asked to pledge your outstanding receivables as collateral on top of the inventory.

You can usually borrow 50% to 80% of the stock’s appraised value, depending on what kind of goods they are and how fast they sell. As you sell your goods, the value of your remaining collateral falls and you can repay the loan.

This is normally used by large manufacturers and wholesalers of physical goods. To qualify you must hold a lot of stock and buy in big volumes.

The term “inventory financing” is often misused. The broader term is “inventory loan”.

‘Inventory loan’ just means any loan you use to buy inventory. ‘Inventory financing’ means the inventory you buy secures the loan.

An ordinary business loan for inventory may want other collateral, a personal guarantee or a blanket lien against all assets.

Inventory financing suits very big manufacturers and wholesalers. Inventory loans come in all sizes. Most small businesses, though, sell small volumes to retail customers.

Most Common Setups

Every form of inventory financing uses your inventory as collateral, but the way the deal is structured differs. The most common setups are a term loan, a credit line, or an asset-based loan against receivables plus stock together. If you sell large volumes, you can get purchase order financing as well.

When you think term loan, think short-term lump sum, paid back in installments. Minimums are often $500,000 or more. You can borrow up to 80% of $800,000, for instance, for a total loan of $640,000. This might work well if you need the money for one big, discounted bulk buy. The catch here is the high minimum amount. It would be better as an ongoing restock solution if you only had to take out smaller amounts when you needed them. Instead it suits one large purchase.

Inventory loans are usually short-term because the inventory is typically sold and used as cash to pay off the loan within a short amount of time.

You only get to borrow against a fraction of the appraised value because inventory loses value over time.

Example: You buy $800,000 of stock at liquidation value. You get an 80% advance, giving you $640,000.

A line of credit backed by stock is called revolving because you can draw, repay and redraw, within limits. The limit rises and falls with the value of the stock. You pay interest plus fees only on what you borrow. This is a great solution for seasonal restocking. An inventory line of credit is more efficient than a term loan when you have ongoing needs. You draw only what you need when you need it.

How it works: your borrowing limit depends on the current value of your inventory. You repay as you sell your goods. It’s a line of credit, so you repay what you take out, then borrow again as needed. You only pay interest on the money you borrow. There are also other fees.

This works best for businesses whose sales dip in slow seasons and want to restock repeatedly rather than make a one-time buy. A revolving loan can help a business deal with any seasonal variations to its cash flow. Maybe your sales sag right before a peak when you need to restock. You know the customers will be there but you don’t have the cash.

Instead of jumping straight to a finance company, ask your suppliers for trade credit. This may cost less than borrowing from a finance company.

With accounts receivable and inventory financing (ARIF) you pledge both your receivables and your inventory as collateral. A lender can combine the two as joint collateral for one loan. You pledge both and borrow against both. You may get up to 70% to 80% of the gross value of the receivables. Invoice factoring is another form of borrowing against receivables. The main difference is that factoring means you sell the receivables outright to a factoring company. Invoice finance means you only get part of the invoice’s value up front. It is useful if your cash is locked up in both unpaid invoices and inventory at once.

Invoice financing, also known as receivables financing, is the short-term borrowing of funds from a third party. You borrow against the money owed to you by debtors. The money loaned to you is usually structured as a credit line, just like inventory financing.

Invoice financing companies don’t give you 100% of the invoice upfront. They never pay the full value, usually 70% to 80%, to protect themselves.

Note that receivables financing is not invoice factoring. Factoring means you sell unpaid invoices outright, getting cash to buy stock.

A purchase order financing firm can provide an advance to let you buy stock to fill a big customer order. The financiers don’t pay you; they pay the supplier. Lenders want to know your customer’s creditworthiness. To be eligible, you must have a large order to fill and a creditworthy client. Unlike invoice factoring, this method is for an order you are trying to fill, rather than unpaid invoices for already filled orders.

Purchase order (PO) financing works if you need an advance to buy finished goods to fill a large order. It’s a good fit for business-to-business resellers. A purchase order advance helps you take advantage of a large customer order that you might otherwise have to turn down because you don’t have the cash on hand to make the purchase.

• First, one of your most reliable customers sends you a purchase order for goods.
• Second, you tell the PO financing company.
• Third, they send the money directly to your suppliers.

Terms Apply to Most Asset-based Loans

Lenders and loans differ. Read each offer closely. The rates below are just a rough guide. Terms also depend on the loan product. The following terms apply to most asset-based loans:

Minimum loan sizes of $500,000 and up are typical.

Advance rates. The most you can typically borrow is 50% to 80% of the appraised value of the stock you are buying.

Qualification criteria. The stock you already have on hand needs to be worth at least twice as much as the loan you ask for.

Rates vary. Rates can range from 8% to 25% annually. Some rates are higher.

Repayment terms. Most terms run from 30 days to a year.

Originating a loan can take as long as 30 days.

The lender may send someone to your place of business to inspect the stock and inventory systems in person. You usually pay for this inspection.

You can lose your stock. This can happen if you fail to pay back the loan or credit line in time. The lender puts a lien on the stock, giving them the right to seize it if you default on your payments.

If you run a smaller business, the terms of asset-based lending may not suit you. You might want to look for an online inventory loan instead. Online inventory loans can be a better fit for a small business. No single option works for every shop.

Inventory Financing Is a Fit for Big Companies

Is it a fit for your business? Inventory financing suits manufacturers and distributors best, though big retailers can also find it useful. If the points below describe your situation and your business, inventory financing may be worth a closer look.

Business model. Be a big firm selling physical goods, usually to other companies.

You need to borrow at least $500,000. You should hold at least $1 million in inventory.

Sales outstripping your capital. Your sales are growing faster than your capital, so you need more money to keep buying.

You will not win higher credit limits from suppliers.

Have open orders. A PO financing firm can help you buy the stock you need to fulfill a big purchase order sent by a customer.

You already have inventory management systems that let you know exactly what and where you have.

Out of financing options. Try to line up a trade credit line with a vendor. If you can’t, try a regular bank loan.

An asset-based loan may cost more than a standard business loan, but it’s usually easier to get for larger, established companies whose goods sell fast.

A lender will care less about your credit history and more about your sales history. For new stock, you can borrow up to 70% to 80%. For your current stock, you could get 50% to 60%.

You can expect lenders to turn down your application if you run a very new company with no sales history. They will also say no if your goods take a long time to sell. The same applies if you expect the inventory’s value to fall fast over time.

It is not a fit for startups or small resellers. A smaller business, like a retailer, is better off applying for a short-term working capital loan or business credit line. Online lenders can provide working capital loans and lines of credit to small sellers.

Even if you do meet the qualifications, consider getting a cheaper loan. Inventory lending tends to cost more than a conventional business loan. If you qualify for a bank loan, consider applying there first.

The amounts you borrow and repay can run very high, while a lender’s due diligence can be strict and time consuming. It’s an involved process, with a lot of paperwork, appraisals and questions. If this is your first rodeo, it pays to hire a loan specialist to guide you and your business through the loan application process. It also helps you find the right lenders for you.

To begin your search for an inventory loan or revolving credit line, try Lendio or a similar online loan matchmaking platform. Compare several offers there, and weigh them against a cheaper loan from elsewhere. Before you sign for any lender, check the terms and costs very closely.