If your small business needs financing, a popular option is to leverage your inventory so you can purchase new items and use them as collateral.

This solution can allow your company to unlock capital and meet customer demand, but what is inventory financing? This guide will explain everything you need to know about these financing loans, their benefits, and whether they have any downsides.

What is inventory financing?

Inventory financing consists of short-term loans that help companies purchase inventory so they can sell them at a later date. These new products are used as collateral.

Many small business owners use this line of credit to:

  • Stockpile and prepare inventory for the next season
  • Cover short-term shortages in cash flow
  • Respond to customer demand and increased sales
  • Expand existing product lines
  • Unlock capital that is currently tied up in products

One of the main advantages of an inventory loan is that it doesn’t require business owners to offer their car, house, or equipment as collateral. Instead, the company assets you use for this purpose are the inventory itself.

All businesses have different inventory needs. For example, you might be looking to purchase a new line of products or cover the costs of raw materials after receiving a large order. Whatever the case, inventory financing can help your company prepare for an increase in demand and guarantee you will always have sufficient stock.

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How inventory financing works

Inventory loans are an excellent option for small businesses with their capital tied up in their products. The amount of money you can borrow will depend on the lender; sometimes, you can get inventory loans for 100% of their liquidation value. Other times, you might have to compare lenders because they might not offer to cover their value completely.

There are two main ways this type of financing works: You can get a loan from a lender or bank to purchase inventory, or you can use a line of credit.

Using bank term loans for inventory financing

A term loan to finance inventory will give you the total amount of money upfront. Then, you will be able to pay it back using fixed monthly instalments over a pre-defined period.

For example, suppose you had to purchase a total of  $100,000 in inventory for the new season. You apply with an online lender who agrees to lend you 80% of the amount ( $80,000) at a 15% interest rate. You pay this total back over 12 months ( $80,000 plus  $12,000 in interest, or  $7,666 a month). After this period, you will have paid back everything you borrowed, and you will again have full access to  $80,000.

Using a line of credit for inventory financing

A business line of credit, on the other hand, is only drawn against as you need to purchase new inventory. In this case, you only pay interest for the portion of the credit line. Once you have paid everything off, your credit limit goes back to the amount that was initially approved.

Continuing with the previous example, if you decided to only draw  $40,000 of your available  $80,000, you would still have access to the remainder. Once you pay the  $40,000 back (plus interests), your credit will return to  $80,000.

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Advantages of inventory financing

Like with any financing option, inventory loans have advantages and disadvantages. Here are some of the benefits:

  • You don’t need to provide personal or business assets to secure a loan; instead, you use your inventory as collateral.
  • Your personal credit history and business credit history are not necessarily deal breakers in securing a loan.
  • You can be eligible even if your business is new (you typically need to have been in business for just six months to a year)
  • An inventory loan is usually very fast once approved.
  • You can free up cash that is tied to your business’ inventory.
  • You will have the flexibility to purchase inventory as soon as you see discounts or bargains.

Disadvantages of inventory financing

The main disadvantage of these inventory small business loans is that if you can’t make the payment, the lender will be entitled to seize the stock owned so they can recoup any outstanding amounts. Other cons include:

  • In most cases, you won’t be offered the full amount required to purchase all inventory.
  • Some lenders will ask for a minimum amount of financing. For example,  $500,000.
  • You will have to calculate your business’ inventory liquidation value (a time-consuming and sometimes costly process).
  • You will have to check in regularly with your lender to monitor the sales and levels of your inventory.
  • The interest rates for an inventory loan tend to be higher when compared to other financing options.

If you secure inventory financing, you should also keep in mind you can only use the loan money to pay for inventory – and no other business purposes.

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Eligibility for inventory financing

Before you can apply for financing to purchase inventory, there are a few conditions you will need to meet in order to qualify.

The first is to have been in business for some time. As we mentioned, your company will need to be at least six months old. Most lenders will, however, ask for a year of comprehensive sales history.

Your eligibility will be based primarily on your business’ previous financial history. It’s best if you can provide inventory records and prepare detailed reports of your sales – including turnover, profits, and projections.

Lastly, you will need to present an inventory system with shipping and return reports, accounts receivable, order receipts, and all the ways in which you safeguard your merchandise.

At Fundsquire, we provide SMEs with several financing options, including R&D tax credit loans, Grant Advance fundingand Revenue Based Financing. If you are looking to extend your cash runway and accelerate growth, our team can help guide you through your entire financing journey with numerous options, connections, and resources.

Looking for funding?

We can help. Fundsquire has funding solutions for every step of your growth journey.

Talk to us