Comprehensive Business Guide to Inventory Financing

A financial crisis can be complex when a company doesn’t have enough assets to apply for a regular loan from a lending facility. However, the inventory constitutes a significant part of a company’s current assets. Efficient inventory adds value to the organization, with stocks held for a short term to meet expected customer demands. However, the company may experience a seizure in capital flow with a high receivable period of its inventory.

Inventory financing allows a company to use its withstanding inventory as collateral to secure a loan to meet the credit requirements in a short-term financial crisis. Inventory financing is an asset-based financial solution for a business to receive any financial aid.

Let us explore how the e-commerce financial term impacts a company’s growth and expansion.

What Is Inventory Financing?​

Inventory Financing is a loan facility extensively backed up by company assets, availed on the value of parts of the business Inventory. The percentage of the loan is set by the financial institution or lender on which the loan is granted and is based on the company’s inventory value.

Inventory financing is a short-term loan or a line of credit in which the inventory serves as a type of collateral. Inventory financing is the loan facility available by entrepreneurs or businesses that own or manage large quantities of merchandise. Small businesses can avail of this loan facility on the following grounds:

  • To cover short-term cash shortages
    For efficient preparation of inventory for a busy season
  • To expand product lines
  • To unlock inventory locked cash flow
  • To secure upfront cash for inventory demand and increased sales

In some exceptional cases, inventory financing is used by retailers, manufacturers, traders, and distributors to purchase their own inventory.

As inventory financing requires the inventory as collateral, the lender or financial institution holds the full right to seize inventory of unsold stock to recoup the remaining amount a company owes the lender.

How Inventory Financing Works

Inventory financing is a common practice for small to medium-sized businesses and wholesalers with large amounts of available inventory. The lack of financial history and available assets to secure large financing solutions forbids mid-sized companies from expanding with profitability.

Inventory financing is a form of an asset-based financial solution that typically allows a business to acquire the required financial aid. General private companies often cannot raise the necessary amount by issuing bonds. Inventory financing will enable companies to use all or a part of their inventory in the form of current assets as collateral for a loan for general business needs.

Businesses rely on inventory financing for several reasons:

  • Keeping steady cash flow throughout the seasons
  • Updating old and new product lines
  • Increasing supply flow to the inventory
  • Responding efficiently to fluctuating customer demands
Inventory Financing in E-commerce

Eligibility Criteria for Availing Inventory Financing​

Though the eligibility criteria vary for every lender or financial company, some of the standard requirements at the time of application are:

  • Age and nationality of the borrower
  • Personal and company credit scores and history
  • Inventory value to be purchased
  • Amount of financing needed
  • Inventory business management system quality
  • Annual inventory turnover ratio
  • Annual income statement
  • Annual revenue, financial statements

Fulfillment Ensures Faster Delivery

Third-party e-commerce fulfillment services speed up delivery, helping e-commerce businesses maintain fast and consistent turnaround times.

Fulfillment Lowers Overhead Costs

Running an in-house fulfillment center means that the business has to bear all the operational costs of a warehouse. Partnering with a 3PL fulfillment company significantly lowers the expense burden, allowing the business to save time and money.

Documents Required for Inventory Financing

An overview of the various documents needed for applying:

60% Shipment Delays

An inventory financing company might want to see the business and personal tax returns, depending on how long the business is structured. At least two years of tax returns are needed to avail of the loan.

Business And Personal Bank Statements

The business or the individual needs to produce their personal and organizational bank statement for at least 6 months to prove the spontaneity of cash flow in the accounts.

Current Inventory List

Current listing of the company’s inventory, including the components, location, and estimated liquidation value, is an important document a business needs to produce.

Company Balance Sheet

A company’s balance sheet reflects the assets, liabilities, and finances of all the operations carried out through the years. The balance sheet is proof of how financially sound the business is.

Profit and Loss Statement

The profit and loss statement is another document to reflect the updated financial condition of the company. Financial lenders may ask to review the profit and loss statements for the previous year or two.

Estimated Sales Forecast

Accurate and updated sales forecast provides an estimated sales structure for the future, which can provide better insight for both the parties for transparent transaction and reliability.

Inventory Management System

Detailed documentation of the inventory management system demonstrates the particulars of the inventory operations like inventory turnover and the number of items sold.

Additional documents required :

  • Filled application form
  • Passport-size photographs
  • KYC documents of partners, co-applicants, or promoters
  • Business PAN card along with GST and Sales Tax registration
  • Company registration certificate
  • Documents with details of inventory as collateral, with invoices
  • Income proof with financials
  • Business address proof
Inventory Financing in E-commerce

Types of Inventory Financing

The classification of loans against inventory primarily depends on the nature of products handled by the business. Based on the distinction, three types of inventory financing must be considered.

  • Inventory Loan
  • Inventory Line of Credit
  • Vendor Inventory Financing

Inventory Loan

Also termed ‘Term Loans’, this financial solution is based on the total value of a company’s inventory. An inventory loan is a simple process through which the business receives funding from a lender to finance its inventory purchases. A short-term inventory loan is a more practical option for small to medium-sized firms with a high inventory turnover rate.
Inventory loans are obtained through banks or alternative financial lenders depending upon the inventory liquidation value, creditworthiness, and overall financial health of the company.

Inventory Line of Credit

An inventory line of credit provides a business with revolving credits or a pool of funds. This allows the business to draw funds as necessary and convenient. This financial solution secures the credit line with the company’s inventory.

Vendor Inventory Financing

This financial service acts directly between the business owner and vendor, without any third-party financial lender. There are two types of vendor inventory financing :

  • Debt Financing – This type of financing allows a vendor to loan money directly to the business to purchase inventory. The debt is paid back with due interest later with sales revenue.
  • Equity Financing – This allows the vendor to exchange goods for shares of company stock. Through equity financing, the vendor becomes an equity shareholder of the company.

Types of Businesses That Can Benefit From Inventory Loans

Well-established businesses with proven revenue history and high inventory turnover rates are ideal candidates for availing inventory financing. However, small businesses like startups and small enterprises with diverse inventory needs or shorter business histories can also utilize this financial option. 

The types of industries that can avail of inventory loans or lines of credit with regular cash flows are:

  • Retail Stores – Stores selling products daily with seasonal needs requiring them to stock up on extra spaces.
  • Wholesalers/ Distributors – Small and medium-sized wholesalers who want to maintain fresh inventory to stay on top of seasonal demands.
  • Seasonal Businesses – Businesses that earn the majority of their revenue during specific times of the year with high accuracy of market predictability. This makes it easier for businesses to rely on inventory financing
  • Automobile Dealerships – The automobile industry often has the highest turnover rate and needs to replenish inventory regularly.
Inventory Financing in E-commerce

Advantages of Inventory Financing

The benefits of inventory financing for small businesses are:

More straight forward application

Traditional business loans can be painstakingly long and tedious. However, with a well-organized inventory structure, inventory financing is a short process and much more convenient.

Additional liquid cash

An inventory loan helps companies bridge the gap between payable and receivable accounts by leveraging inventory.

No risk of self-collateralizing

Inventory financing only needs the business to keep its inventory as collateral against the loan. Hence no need for personal assets or valuables to be held as collateral.

Fast processing

Inventory financing is relatively quick compared to traditional loan facilities. With just the inventory kept as collateral, the process involves much less paperwork and processing time.

No personal credit score required

Company owners need not worry about their individual credit scores to apply for inventory financing. Since the inventory is considered collateral, it is possible to avail inventory financing without any credit check.

Boosts overall sales

Inventory financing, when used strategically, results in an effective boost of sales for small to medium-sized businesses. This allows a company to restore depleted stock in case the demands outpace supplies.

Recurring funds available

The inventory line of credit allows a business to withdraw funds on an as-needed basis.

Disadvantages of Inventory Financing

The drawbacks of inventory financing are as follows:

Restricted loan amounts

Inventory financing usually ranges from 20% to 70% of the inventory’s appraised value. No extra finance is lent, which is more than the stock is worth.

High-interest rates

As inventory financing doesn’t require personal guarantees, this financial aid is deemed high-risk by financial lenders or organizations. The interest rates hover around 8% to 12%

Tough to get approval

Though loan processing is relatively quick, it takes a while for the lenders to assess the application. Companies with more successful products tend to have a more developed and faster application time.

Inflexible repayment

In addition to higher interest rates, businesses must repay automatically to minimize default risks. The cash generated from sales is used directly for the loan repayment.

Expensive due to diligence

The biggest challenge to inventory financing is the potential length and expense of the approval process. A lender can conduct due diligence on the company before granting an inventory loan.

Loan covenants

In a financial agreement, creditors tend to specify specific rules like loan covenants with which a business is bound to comply.

Unpredictable risks

Inventory financing can be risky if the company’s sales performance is unpredictable and unstable.

Large installment payments

Inventory loans are short-term in nature. Therefore, installment payments tend to be large, putting the business under immense financial pressure when paying off debts.

Costs Associated With Inventory Financing

The rates, fees, terms, and conditions tend to vary depending upon the mode of borrowing. 

The standard fees included with a business inventory loan are:

  • Application and/or origination fees: Costs incurred in reviewing the application and the advancement of the loan. 
  • Appraisal/inspection fees: Costs required to undertake a manual intervention to inspect and appraise the inventory’s total value.
  • Prepayment fees: Additional fees are required in case the borrower wants to carry out early repayment, ahead of the terms set by the loan agreement.
  • Late fees: Amount incurred in case of late loan repayment.
Inventory Financing in E-commerce

Interest Rates Associated With Inventory Financing

An eligible company is fit to avail of inventory financing with interest rates ranging from 1% to 99%. While banks and government-aided lenders provide accessible rates, other private lenders can incur much higher interest rates against the money borrowed. Generally, an eligible company can expect the following interest rates from the following lending facilities

  • Banks: 3% to 6%
  • Online lenders: 8% to 99%
  • Inventory financing company: 8% to 20%

Steps Involved in Availing an Inventory Financing Loan

Step 1 - Determining the exact amount and type of inventory required

The first step for applying for inventory financing is determining an estimation of the amount of money a company needs. Get an accurate estimate by closely analyzing the sales patterns and seasonality along with economic factors that can affect direct consumer activity.

Underestimating the inventory needs can lead the business to scramble for more stock, whereas overestimating can lead to unnecessary hefty payments and unsold inventory.

Step 2 - Determining Eligibility

Once the inventory’s initial evaluation is completed, a company needs to assess whether it is eligible for obtaining inventory financing or not.

Step 3 - Choosing an inventory financing lender

A business needs to choose a financial lender based on its requirement. 

Step 4 - Accumulating required documents to apply

While applying for an inventory loan, a company should ensure all documents are present. This documentation provides a comprehensive overview of the company’s financial scenario.

Step 5 - Complete the application

Once the documentation process is complete, the business is ready to fill out the application form and submit it with the documents.

Step 6 - Go through the due diligence process

‘Due Diligence Period’ is considered an investigation period for the business. Since the due diligence process is lengthy and complex, a company can sign a loan agreement beforehand to reduce the risk of overturning. During the due diligence process, the borrowing company may need to submit a field of audit of the business.

Step 7 - Review the offer and wait for approval

Once the initial application process and due diligence process are completed, the lending facility needs to produce a non-binding offer, including details of the loan interest rates and terms. The borrowing company must wait for the final decision after completing the application.

Step 8 - Submission of the final paperwork

After final scrutiny of submitted applications and documents, the last step leads to the final paperwork, including the official contract with due details of the loan, rate, and terms. The company is eligible to receive funding at the end of the process.

Alternatives to Inventory Financing

Inventory financing is a convenient option to aid fast-growing businesses to practice spontaneous inventory operations and fulfilling customer needs while maintaining a steady cash flow. However, in case any business fails to match the eligibility criteria to take up loans from banks or any other lending partners, here are some alternatives to inventory financing which can aid the company in short-term or long-term finance solutions.

A business line of credit

Provides access to the maximum amount of funding with interest on unpaid balances.

Business credit cards

Designed for short-term business needs, this provides a revolving line of credit with due interest charges on unpaid balances from earlier billing cycles.

Online business loans

Online lending facilities offer similar loan options as a traditional bank, with a fast approval process for people with lower credit scores

Merchant cash advance

Helps small businesses to borrow advance cash for specific business expenses in return for a portion of their future profits.

Equipment financing

Allows finances for machines, tools, vehicles, and other business-related equipment.

Personal loans

An individual can also avail of personal loans for business or personal expenses.

SBA loans

Government-aided Small Business Administration loans are offered by banks and SBA-approved lenders

Commercial real estate loans

Loans for purchasing buildings or spaces for business use and development.

Invoice factoring

Sending invoices to a third-party factoring partner responsible for collecting payments from customers

Term loan

Individuals or companies with strong credit scores and solid financial statements are qualified for unsecured loans without collateral.

Short-term loans

Short-term loans are term loans that have a shorter repayment period. Short-term loans can help purchase inventory if you expect a relatively quick turnaround and have a little borrowing need.

Conclusion

Inventory financing is a quick-term, asset-based lending operation that allows eligible businesses to borrow liquid cash. Inventory can be used as collateral to receive short-term, asset-backed funds to offset company expenses unrelated to inventory. If a business avails money using this approach, they may use the inventory provided the repayments are made on time. If the firm does not make the repayments on time, the lender has the absolute right to seize the inventory or any other inventory of the same value.

Inventory financing is a preferred alternative for retailers, manufacturers, and dealers to handle their emergency credit needs as a result of its quick money availability. Inventory financing can be used as a financial solution to improve cash flow, increase sales, and prepare for a busy season for small to mid-sized companies, in addition to helping them receive funds at a discounted price. Inventory financing is an excellent financial solution for companies with enormous inventories that cannot apply for traditional loans at a bank.

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FAQs

Inventory financing is an asset-based loan allowing a business to purchase inventory or carry out inventory expenses as needed. An inventory financing loan is credited with the inventory as a collateral asset.

There are two distinct types of inventory financing, namely:

  • Inventory loan – is a one-time loan offered to businesses to cope with emergency cash requirements against inventory sales.
  • Inventory line of credit – is an ongoing funding solution to ensure capital stability for regular business expenses.

The best ways to finance inventory are:

  • Short-term financing – is the most convenient method that matches the business Inventory turnover as per the business nature. 
  • Vendor financing – the financial facilities acting directly between the business and vendor for inventory operations
  • A business line of credit – a flexible line of credit providing revolving credits for repeated usage.

The funds received from the inventory financing scheme, which can increase the cash flow within a business or allow the company to expand its operations, are known as inventory financing costs.

Inventory is a current asset as the business invests in inventory that converts into revenue when the stock is sold.

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