How to Use Your Inventory as a Financing Opportunity

Do you need cash or a line of credit fast, but are unsure of how to get access to it? Do you have or plan to order inventory? If so, you may be able to leverage your inventory as a quick loan. 

It’s not a pawn shop scam. It’s a way to leverage your merchandise as collateral for a loan. A way to meet the market demands without compromising your organizations financial health. 

This is one way small businesses can meet rising demand without straining your finances, regardless of your credit score. You’ll be able to meet your customer’s needs, and avoid missing out on sales or losing customers to your competition. 

Who doesn’t want the dream of consistent cash flow and well-stocked inventory? Here’s everything you need to know about inventory financing. 

What is inventory financing?

Inventory financing is an asset-based lending, line of credit or short-term loan to purchase inventory now and sell it later. Your products or inventory act as collateral for the loan. Inventory financing is ideal if you need to purchase a large amount of inventory quickly, like for a season, a new customer, or an unexpected increase in demand. 

Companies often use this loan to purchase more inventory, maintain operations, or support growth without depleting cash. Once the money is procured, the business can avoid stockouts, keep up with customer demand, and maintain their competitive advantage – without selling equity or incurring burdensome debt. 

What happens if you default on inventory financing?

If you default on your inventory financing loan, the bank can seize your inventory and resell it to cover the loaned amount. 

Two Types of Inventory Financing Loans

There are two different types of inventory financing loan options, inventory loans and inventory lines of credit. 

Inventory Loans: When it comes to inventory loans, the bank provides you with the entire amount for the loan upfront. You’ll repay the loan over a specific period of time, with interest. This is commonly used for one-time, large purchases. 

Inventory Line of Credit: When it comes to inventory lines of credit, a bank provides you with a credit limit to draw upon when you need it. You repay the amount you borrow monthly, and only pay interest on the amount that you’ve borrowed. This is a revolving credit, rather than a one time credit, so it can be used to purchase inventory multiple times. 

Who can use inventory financing?

Businesses that successfully leverage this type of loan often carry a significant amount of inventory and are in the following industries:

• Wholesalers
• Retail
• Manufacturing
• Distribution
• Ecommerce businesses 

Any business that has physical products or materials and needs an influx of cash can apply, even if they’re outside of these industries. 

How to Secure an Inventory Loan

Here are the six steps to getting an inventory loan. 

Step #1: Find a Lender

There are a couple of different types of lenders that provide inventory loans including banks, credit unions, and online lenders. You may want to consider working with a lender that has experience working in your industry. 

To determine if a lender is a good fit for your organization, start by double checking that your organization is within their business operation duration. While some lenders will work with businesses as old as six months, others require a year or more. The longer you’ve been in business, the more likely you are to be approved. 

You’ll also want to see if they have any credit score limitations. The higher your credit score, the better your odds are of being approved by a lender. 

Next examine the organization’s requirements to fill out an application and for approval. There should also be an average borrowing amount offered and information on the interest rates they offer. 

Step #2: Provide Financial Information

Before you apply, you need to gather the necessary financial information and documents to make sure you’re prepared. Some common documents requested for inventory loans include:

• Balance sheets
• Cash flow statement 
• Sales history
• Profit and loss statements
• Future sales forecasts
• Business bank statements
• Inventory list
• Business plans
• Inventory turnover ratios

For your business bank statements, you’ll want to include a summary of transactions based on the length of the loan that you want. For your inventory list, you’ll want to include what inventory you currently have, as well as an estimated resale value. 

Once you have all these documents ready to go, you can complete the loan application. On the application, you’ll include details on the loan amount desired, type of inventory you’re using or will use as collateral, and extra details on your business’s financial situation.

Step 3: Get an Assessment of the Collateral

Up next, the lenders will evaluate the value of your inventory. This sometimes includes physically verifying the quantity and condition of the inventory (if you already have it) to determine your loan amount. They will assess the market value of the inventory by considering:

• Raw materials
• Work in progress
• Finished goods
• Condition (new, used, obsolete)
• Current market value 

The turnover rate of the inventory is a critical factor when it comes to getting an inventory loan. High-turnover inventory is more valuable, given that it has a lower risk of being obsolete or depreciating. 

The lender will then determine the liquidation value of the inventory to determine your loan amount. This number is basically what they think they could realistically sell your inventory for should you default on your loan. 

Step 4: Loan Approval

Once the assessment and audit is complete, the lender will determine the loan amount you qualify for. Normally, the loan covers a percentage of your inventory rather than the value of all the inventory you have or plan to buy. The range is typically between 20% to 80% depending on the lender, inventory type, and your businesses financial health. 

Ultimately, banks want to ensure they can sell you inventory quickly to recover funds if you default on the loan. So, they’ll provide you with a loan that discounts your inventory compared to its market value. They’ll also take into account the storage costs while selling your inventory, any selling costs and market volatility. 

Step 5: Loan Terms

More often than not, lenders include interest rates, fees, and repayment terms with your loan or line of credit. Review these terms carefully given that you’ll be signing a legally binding contract. 

Step 6: Loan Disbursement

Once you’ve accepted the loan terms you’ll receive the funds or access to a line of credit. 

Pros of Inventory Financing

There are lots of positive reasons business owners consider getting an inventory loan for their business.

Increase purchasing power and investments: When you have more capital, you can purchase more inventory or invest where you need it, like marketing, research and development, new equipment, expand to new markets, etc. 

Improve cash flow: A loan can help you manage cash flow more effectively. 

Reduce risk: Receive financing without pledging other business assets or a  personal guarantee. 

Faster access to capital: An inventory loan can be in your bank account relatively quickly when you need cash fast. 

Flexibility: Depending on your terms and conditions, an inventory loan can help you invest where you need it most. 

No equity dilution: Get access to funding without giving away ownership of your company. 

Better supplier terms: With an inventory loan you could potentially order items or materials in bulk, unlocking lower rates on the things you already need. 

Improve your credit: If you’re able to make payments on time, you’ll be able to improve your credit, unlocking even more opportunities for your business. 

Inventory loans also have straightforward applications that are faster to complete than conventional loans.

Cons of Inventory Financing

While inventory loans do offer a lot of positives, there are some drawbacks to this type of funding. 

Limited loan amounts: You’ll likely only receive 20% to 80% of your inventory’s appraised value. 

Higher interest rates: Since this loan is a high risk loan, it often has higher interest rates compared to other loans. 

Inflexible repayments: Automatic repayments each month maybe included in the terms and conditions. 

Loan covenants: Lenders are able to include specific rules in your contract. This could nclude an insurance policy on collateralised inventory or requirements on how to use the funds provided. 

Unpredictable risk: To repay the loan you’ll likely need to consistently move inventory. There’s no guarantee when it comes to sales, and sometimes snags happen, like a container ship blocking a major shipping canal. 

Personal risk: You may have to sign a personal guarantee, which puts your inventory and your personal assets at risk. 

Restrictive covenants: With this type of loan, you may not be able to borrow from other lenders. 

Be sure to weigh the pros and cons, as well as the terms and conditions for your specific loan carefully before agreeing to an inventory loan.  

Is an inventory loan right for you?

There are many factors that go into considering if an inventory loan is right for you or not. Keep in mind that the value of your inventory may fluctuate, potentially impacting the loan and your ability to make payments. Ensure your inventory turnover is healthy and that you can sell the inventory leveraged to repay the loan. 

If you do fail to repay the loan, the lender can seize and sell your inventory to cover the balance, and anything else noted in the terms of the loan. Yet, if you need financing fast, and feel comfortable with the risk, an inventory loan can be a great way to grow your business. 

Want more tips like this delivered straight to your inbox on a regular cadence? Sign up for our email list below. We help small to medium sized businesses grow with helpful tips and tricks, as well as physical cowarehousing spaces. 

Or check out our article What to Look for in a Production Warehouse.