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Inventory Financing
What is inventory Financing?
Businesses can get money to buy goods to sell through inventory financing. This kind of funding is typically in the form of a credit line or a short-term loan, with the goods you buy or your current inventory serving as security.
Inventory financing is available to businesses only and cannot be availed as a personal loan. Enterprises in the retail, wholesale, and manufacturing sectors may find inventory financing to be a helpful source of capital. Throughout a busy season, it can assist in keeping your shelves filled or enable you to purchase goods in large quantities at a discount.
What are the types of Inventory Financing?
There are two types of inventory financing that lenders offer to businesses. The choice the company makes depends on how its business is run. The lender and the nature of the business will affect the interest and fees.
- Inventory funding: The total market value of the organization’s stock is the basis for inventory financing. It is also known as a term loan. The lender gives the business a specific sum of money, just like with a standard loan. The business agrees to repay the loan in full after the stock is sold, make fixed monthly payments, or both.
- Line of credit: With this type of financing, businesses are given access to revolving credit. As long as they’re making payments on time and adhering to the terms of the contract, it provides them consistent access to capital.
How does Inventory Financing Work?
Inventory financing is an example of asset-based financing. Let’s take a look at the steps involved in getting a financing loan for your business.
Step 1 – Businesses go to financiers. You approach financing companies to get the financial support you need to buy the supplies you need to make the products to sell later.
Step 2 – You offer business collateral for the loan. Businesses are allowed to use all or a portion of their current inventory or the materials they buy as security for a loan used for operating costs.
Step 3 – The lender analyzes your requirement and collateral. The financing company will analyze the amount you require, the collateral you can offer, and often also your business history. If you’ve been in business for at least one year or more, it will be easier for you to qualify for the loan.
Step 4 – The lender will decide the type of loan they can offer. If they offer a term loan, you can get a lump sum of money to buy your stock and then repay the loan over time with interest. On the contrary, if they offer a line of credit, you will be given a credit limit from which you may draw to buy your inventory.
Step 5 – You must consider all the offers and finalize one. You must carefully consider all the offers you have and choose one option depending on the type of loan they offer and their credit terms. Their repayment policies must be suitable for your business.
Step 6 – You receive the money or line of credit. You can then use the financing support to advance your business.
It’s important to note that you might not always be granted a loan for the full amount of the stock you wish to buy. An inventory financing provider may just finance between 50% and 80% of the inventory’s estimated liquidation value, much like how real estate or machinery loans work. Lenders make sure they will be fairly compensated if your company is unable to repay the loan by setting the liquidation value frequently lower than the current market price of the inventory.
benefits of inventory Financing
- Businesses can qualify for inventory financing without relying on their assets or the credit history of the business.
- Over extended periods of time, businesses can supply more products to their consumers.
- Leveraging inventory loans or financing can help most businesses purchase additional inventory or even to purchase initial stock for new businesses.
- Younger companies can easily and quickly access a line of credit when they do not have sufficient financing support of their own.
disadvantages of invoice factoring
- Repayment of the loan may be difficult for young and struggling businesses.
- The entire amount requested may not always be advanced by lenders.
- Lenders may apply higher costs and borrowing rates for start-ups or companies that may be struggling to stay afloat.
- Loan resources for new or struggling businesses may be very few and the loan application may not always be approved. However, an online inventory financing provider is a good option for such businesses to apply for an inventory financing loan.
How can you qualify for Invoice Factoring?
The policies for inventory loans vary depending on the lender and financing firm. While it is possible to come across lending institutions that only require six months’ worth of operations, the majority of lenders will demand that you possess at least one year of experience.
When you apply for external funding, you can typically anticipate them to take into account any of the following:
- Credit histories and scores for individuals and businesses
- Required funding amount
- The estimated cost of the inventory that will be bought
- The effectiveness of your company’s inventory control system
- Average inventory turnover rate
- Annual income
- Financial information like cash flow and profit and loss statements
Factors like collateral, the age of your business, and your ability to repay the line of credit/business loan typically affect your eligibility more than your personal or business credit history. These factors are typically the most crucial for receiving approval for inventory financing.
What is an example of inventory financing for businesses?
Let’s look at an example to better understand how inventory financing for businesses functions:
Let’s say you own a dealership and would like to invest $1 million in brand-new vehicles. When you contact a lender about getting an inventory financing loan, they will hire a third party appraiser to value your inventory (online lenders typically won’t do this). The appraiser determines that the cars have a market value of $750,000. You will be given an inventory loan or business credit line for $525,500 if the lender’s policy is to lend 70% of the inventory’s estimated market value.
You will receive the entire amount at once if the loan is set up as a term loan, as discussed above. You can purchase the vehicles with the money and then repay the loan plus interest. In contrast, if the funding is set up as a line of credit, you can take out cash as necessary to settle your vehicle purchases. Then you can repay the amount borrowed with interest over a predetermined period of time.
Key Points
Key Point 01
One time lump sum, paid down over time.
Use for expansion, capital improvements, and large purchases.
Key Point 02
Cash when you need it most
Use for recurring expenses, payroll, inventory replenishment
Key Point 03
One time lump sum, paid down over time.
Use for expansion, capital improvements, and large purchases.
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Frequently Asked Questions
Inventory financing is typically meant to be a short-term loan to help you purchase inventory. It may be a longer-term loan if your loan amount is high, depending on your loan terms and your lender’s policies.
No. You may also choose a business loan with a traditional term (usually between 6 months to a few years). However, these loans are difficult to qualify for and often require a strong personal and business credit history. Inventory financing for businesses can be availed from newer lenders who have fewer qualification criteria.
Term loans and inventory financing can function similarly. However, an inventory financing loan can only be used to pay for purchasing inventory items while term loans can be used to pay for any business requirement.
As with term loans, the inventory financing option can function similarly to a credit line, but they are not the same. Business credit lines can be used for most business expenses while inventory financing can only be used for purchasing inventory.
You can use an inventory loan for as long as your loan tenure. Within your tenure, you can use the loan to purchase inventory as often as needed, given that you still have sufficient credit left.
Many small business loans can be very expensive. However, an inventory financing loan may not be expensive because it holds your current or future inventory as collateral. The lenders are assured their money will be repaid.
A business inventory loan is meant to bridge a cash flow gap for existing small businesses. As such, your credit history is not so important as the fact that you have enough inventory to put up as collateral. It’s also important that you’ve been in business for a while.
No. A business inventory financing loan is not meant to add to your cash flow. It can be used only for purchasing inventory.