Find out all about inventory financing, and whether it is a good fit for your business needs.
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Inventory financing refers to a line of credit or loan that a business owner can use to purchase inventory. Certain financing options may require your inventory as collateral, while others are unsecured. In the case of the latter, you’ll be assessed based on factors such as your business credit score and the strength of your cash flow.
In general, your lender will advance up to 80 percent of the appraised value of your inventory. Lenders will typically use the Net Orderly Liquidation Value (OLD) or the Forced Sale Liquidation Value (FLV), which can be considerably less compared to the market value.
Common uses for inventory financing include:
Keeping a well-stocked inventory: Inventory financing provides businesses with the working capital they need to maintain a well-stocked inventory. This can help prevent situations where a company runs out of products or goods, which can lead to production delays or lost sales, where customers turn to competitors to obtain the products they need.
Managing seasonality: Inventory financing can be a handy tool to help businesses prepare for peak periods, such as purchasing additional inventory ahead of a sale or festive season.
Capitalising on time-sensitive opportunities: With inventory funding, you’ll be better positioned to seize unexpected opportunities that arise - such as special deals and clearance sales.
The following are general requirements that can help you assess if inventory financing is a good fit for your business:
You’re running a product-based business: Inventory financing provides businesses with the working capital they need to maintain a well-stocked inventory. This can help prevent situations where a company runs out of products or goods, which can lead to production delays or lost sales, where customers turn to competitors to obtain the products they need.
You have at least a year of business history: Lenders need to assess your business’ previous financial and inventory records, so inventory financing isn’t an option if your venture has only recently commenced operations.
Your business has high inventory turnover rates: Lenders want to finance fast-selling inventory; they need to know that your goods are a viable collateral they can easily sell off should you default on the loan. If you’re having difficulty moving inventory off the shelves, chances are that your lender won’t accept it as collateral for the loan.
You don’t require funding immediately: Certain lenders may require that borrowers undergo a due diligence process. The process involves a review of your business financials and credit history, along with an assessment of your inventory, accounting and inventory system, storage facilities, inventory turnover and loss or damage rate. This can be time-consuming, and it can take weeks or months before you gain access to funding. As such, inventory financing may not be a good option for businesses that are in need of cash right away.
You require a large amount of financing: As mentioned above, inventory financing requires extensive due diligence. Due to the effort involved in the assessment process, lenders typically impose high loan minimum requirements. Certain lenders may require that borrowers obtain a minimum loan amount of at least $500,000.
Create a checklist of questions to better assess potential lenders
Doing the legwork beforehand will help you better assess potential lenders, and choose a partner that’s a good fit with your business needs. Here are a few key questions you’ll need to include in your evaluation process:
How long will it take to for the approval process and funds to be transferred? The approval and onboarding processes will vary from lender to lender; for certain lenders, it can take months before your application is approved and funds are made available. You’ll want to skip over these companies, and instead seek out lenders that can review your application within days, and provide access to funding within one or two weeks.
What are possible repayment term options? The repayment terms will vary between lenders, and are also dependant on other factors - such as the size of the facility and complexity of the line. Certain lenders might require a full repayment to be made within six months, while the repayment terms for others may be a year or longer. The key here is to review your inventory data, and work out a feasible time period where you can make repayments on time, without having the need to take up additional financing within the duration of the loan.
What are the inspection processes like? If your lender has established that inventory inspections are necessary, get clear on what the process involves, as well as any requirements that you’re expected to fulfill.
What are the reporting processes like? The reporting processes may vary across lenders, with some laying down stringent requirements such as weekly or monthly updates. Make sure you understand fully what you’re expected to do, and that it’s feasible for you to fulfil these obligations.
It’s not unusual for lenders to make an unplanned inspection; certain lenders may require that inspection processes be carried out periodically - such as once every three or six months - as long as the line of credit is maintained. Therefore, you’ll need to ensure that your offices, storage facilities and staff are prepared for these visits.
Measures that you can implement include conducting staff briefings and mock inspections. You’ll also need to review the environmental conditions of your storage facilities, paying close attention to factors such as the temperature and humidity, as well as whether your inventory is well protected from external elements.
From minimum lending requirements, to extensive due diligence checks and lengthy onboarding periods, traditional lenders often have stringent criterias and processes in place - which can make it challenging for small businesses to qualify for inventory financing.
But banks and inventory financing companies aren’t your only options. Business owners may also turn to online lenders for short term loans or inventory lines of credit to obtain the working capital they need. Offering streamlined application processes and greater flexibility, these lenders can be a viable option for businesses that aren’t eligible for traditional financing solutions.