Your inventory is down, and you need cash to restock. The bank said no to a loan. Your customers are calling for the stuff you don’t have, so you know it will sell. No cash, no stock, no sales, and no business.
Can you use the stock itself as security for a loan? If not, what other options exist? Below, we’ll help you decide if this fits your situation.
Most loans rely on collateral. This is something you give or assign to the lender that’s forfeited if you miss payments. Inventory financing is a type of asset-based loan. The asset is whatever stock you buy with the borrowed money. Some lenders also want your accounts receivable (unpaid sales invoices) as well.
Most will lend you 50% to 80% of the appraised value. The percentage depends on the type of goods and how fast they sell. You repay as you sell the goods. Every time goods sell, part of the money goes back to the lender. So as the stock leaves the warehouse, the loan shrinks.
The service usually works best for large upstream manufacturers and distributors. That’s because you need to maintain substantial inventory and buy in large volumes. So a business that buys goods in smaller batches might not have the right inventory for inventory financing.
You might hear people mix up inventory financing and “inventory loan.” Here, the shorter version is the umbrella term for multiple options.
When people say “inventory financing,” they mean a loan that uses the purchased stock as collateral. An “inventory loan,” on the other hand, can be any type that you use to fund buying goods.
The bank might also want any other collateral you have, a personal guarantee from owners or partners, or a lien on all your business assets.
Asset-based lending works better for large B2B companies. Other types of inventory loan can work for small B2C businesses.
Inventory Financing Arranged in a Few Common Ways
All inventory financing uses the inventory itself to secure the deal. The lender, though, might structure the contract in different ways. You’ll need to understand what you’re signing up for and how to use it. You’ll see inventory financing arranged in a few common ways, including term loans, revolving credit lines, receivables-and-inventory deals (ARIF), and purchase order financing.
An inventory term loan comes as a short-term lump sum repaid in installments. Minimums usually sit at a half-million dollars or more, which means it’s best for large businesses. You get an advance worth a percentage of the value, such as 80% of an $800,000 liquidation value, which comes to $640,000. You pay back the loan in installments of principal plus interest. Unlike a secured credit line, a term loan works best for a single purchase. Some of these types also renew easily, letting you increase your stock as necessary.
These are short-term loans, usually less than a year, because the goods are expected to sell quickly. You receive the full amount upfront and repay with the lender’s interest rate as part of the regular installments.
You usually get only a percentage of the liquidation value — think 80% or less — because stock loses value over time. Why so cautious? If you default on a loan, they must sell off your stock, and it doesn’t fetch much.
A term loan is a good option for one big purchase, especially when you come across fast-selling stock you can buy at a discount.
An inventory line of credit works like a credit card, but one backed by your goods. The lender sizes your credit by the value of the stock. You can draw as much as you need, provided it doesn’t go over the limit. As you sell and repay the lender, the available amount refills. You only pay interest on what you use, as well as fees. In practice, with a line of credit, a business whose sales slow down for the season will draw from the line to restock before the busy months. They repay the loan as goods sell, so the cash is on hand to rebuy before the busy season ends.
Lines of credit are one of the most frequently used setups. Because you keep tapping funds to restock, this serves as a more flexible deal than a term loan. With a term loan you borrow once and pay it down. With a line of credit, you borrow, repay and borrow again as necessary.
This works best for keeping up with regular restocking needs rather than a single big purchase. This will help you manage costs even if your sales ebb at certain times of the year.
Before you go to a lender at all, ask whether your vendor will extend credit to you. This works best if you’ve done a lot of business with a supplier and paid them regularly on time. Why start with vendor credit? There’s no bank in the middle, and the vendor wants to keep your business.
A combined advance is another option. Lenders sometimes let you pledge both your receivables and stock as collateral for a loan. This is called accounts receivable and inventory financing, or ARIF. The lender advances 70%-80% of the invoiced amount. The percentage is low because a few invoices will never be paid in full. Receivables factoring works differently. With that setup, you sell your outstanding invoices to a factoring company, which pays you upfront. They’re the company’s now, not yours. With ARIF, by contrast, you still own the invoices, as well as the stock. They just secure the debt.
ARIF blends both accounts receivable and inventory loans into one advance. This is better for those with cash tied up in both unpaid invoices and stock.
Accounts receivable financing lets you borrow against sales invoices that haven’t been paid yet. This usually sits as a line of credit sized by the value of unpaid invoices. Both are asset-based lending, so they can fund one loan or line together.
You can also sell unpaid invoices outright to a factoring company in a practice called invoice factoring. This also turns invoices into cash you can use to buy stock.
Businesses that work as middlemen between suppliers and retailers can also ask for a purchase order loan. On a typical PO financing deal, a big order comes your way but you lack the cash to pay suppliers. The lender pays the supplier directly, leaving you with time to finish and ship the order. The customer has to be creditworthy, because this depends on their ability to pay you once you’ve delivered. Unlike invoice factoring, which is based on completed orders, this is for those still being filled.
PO financing gives firms an advance to buy stock required to fill large customer orders. It works well for firms buying and reselling finished goods.
It starts when you receive a purchase order from a creditworthy customer. The PO finance company then pays your supplier for the goods, which you use to fill the order.
General Features
Rates and terms vary by the lender and type of deal. Some general features show up in almost every agreement, though.
Minimum loan amount: Most loans and lines of credit start at a half-million dollars or more.
Existing inventory requirement: You must have inventory on hand worth at least twice what you’re asking to borrow.
Interest rates vary by lender and borrower. Rates have a lot of room to move, from around 8% to 25% or more.
Repayment terms: Usually you’ll repay in small regular payments throughout the duration of a 30-day to 12-month contract.
Funding speed: It can take as long as 30 days to arrange a term loan or line of credit.
The lender may send an inspector out to view your stock and inventory system on-site. You’ll pay the cost.
Default: If you fail to repay as agreed, the lender seizes the stock.
If these terms sound like too much, smaller firms may do better with online inventory loans.
Manufacturers, Distributors
Inventory financing fits manufacturers, distributors, and now and then a huge retail chain that may operate in multiple locations. See if these describe you.
- You run a large business that sells physical products, most likely B2B.
- You need to borrow at least $500,000 and hold at least $1 million in current inventory.
- Your sales have increased quickly, and your capital can’t keep pace.
- You’ve reached the limit on credit with vendors, or the suppliers no longer extend credit at all.
- You’ve received several purchase orders that you can’t fill unless you can buy more merchandise.
- You operate an efficient inventory management system that keeps products rolling from buyer through shipping.
- You’ve tried other options like a vendor credit line or a conventional business loan, only to run into high interest rates or an out-and-out rejection.
Inventory financing can come to more in interest than conventional loans. Yet it’s easier to get for larger, established firms that can turn stock fast.
Your credit score isn’t that important, but a solid sales history is. The lender’s counting on the stock selling to repay the loan. You’ll generally see advance rates of 70%-80% for goods you’re buying versus 50%-60% for existing stock on hand.
If you’re a brand-new outfit with no sales history, or if you’re holding a large inventory that’s losing value and not selling, you’ll have a hard time finding lenders.
Inventory financing isn’t built for startups or small B2C firms. A retail owner who needs only $50,000 in stock can turn to a short-term working capital loan or a business line of credit instead. If you don’t have sales numbers to show or your needs are far below the $500,000 minimums, you’ll likely be turned down.
Just because you’re approved doesn’t mean it’s your best option. Inventory financing costs more than other loans. If you can get an SBA 7(a) business loan at a better rate, take it and get funding that way. Before you sign, add up the total interest you’ll pay, along with every fee the lender charges, and put that next to the total cost of the other loan options you have open to you.
Inventory financing is complex, and lenders do heavy due diligence. It helps to hire a broker specializing in asset-based lending. A loan specialist with experience in asset-based loans knows which lenders lend money on your kind of inventory and what each one wants to see. They also know how to prepare you for the appraisal, inspection, and due diligence, which saves time.
If you’d rather shop around yourself, an online marketplace such as Lendio matches borrowers with lenders and may help you get inventory financing.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
