How Does Inventory Financing Work?
Inventory financing is a form of asset based lending that allows you to leverage your inventory. This can help improve your company’s cash flow and provide funds to pay for business expenses, or to buy more inventory. This type of financing is useful if you are unable to get higher credit terms from suppliers/vendors, or if they are asking for faster payments.
In this article, you will learn:
- What is inventory financing
- How it works
- Advantages of the solution
- Alternate options
The right strategy
The first thing we should say about this solution should be used strategically. In most cases, inventory financing should not be your first option of financing. This is because it is more costly than that of other alternatives.
Instead, you should consider trying to finance your receivables first. This can be done by using a factoring line or by getting an asset based loan. If these solutions don’t render sufficient funding, at that point you should consider financing inventory.
How does it work?
The line is usually offered in combination with a factoring line or as part of an asset based loan. It allows you to finance inventory shortly after it has been purchased. Your company get’s the funding by submitting a draw request to the lender, who deposits the funds in your bank account. Once you have the funds, you can dedicate them for any business expense. Transactions settle regularly as inventory is turned into product and sold off to customers.
The lender funds inventory by advancing up to 80% of it’s appraised value. However, lenders don’t use the market value of the inventory in these transaction. Alternatively, they either use the Net Orderly Liquidation Value (OLD) or the Forced Sale Liquidation Value (FLV). Note that the OLV and FLV are usually lower, sometimes substantially, than the market value. This can affect your ability to leverage your inventory.
Who can use inventory financing?
Our inventory financing program can be used by wholesalers, distributors, and manufacturing companies:
- Need a minimum of $500,000 in financing
- Have an inventory that is marketable
- Use a management system with ageless inventory
- Have reliable financial statements
- Have exhausted other options (e.g. factoring, ABL, line of credit, etc.)
This type of financing has some advantages over other solutions. Some advantages include:
- Allows you to leverage inventory
- Allows your business to accumulate inventory (i.e. to meet contractual obligations)
- Easier to get than conventional financing
- Line can increase as your company grows
Due diligence can be expensive
One of the disadvantages of this solution is that it require more due diligence than other alternatives. This is due to the quality of inventory itself, which requires additional financial controls. The due diligence can be a pretty penny for some, which is why it only makes sense to use this type of financing if your company needs a minimum of $500,000.
- As part of the review process, the finance company will need to:
- Perform a field test of your facilities
- Review your accounting system
- Test your inventory system
- Appraise your inventory
Some of these functions are conducted by third parties who must travel to your plant or warehouse. Initial costs vary based on the size of the facility and the quality of the line. Also, the financing company will need to watch over your inventory regularly, usually every three to six months. These investigations add to the maintenance cost of the line. This is the main reason we recommend you exhaust other financing options first.
One option that can be used to finance certain inventory transactions is purchase order financing. This is a very specific type of funding that allows you to finance inventory that is associated with a specific purchase order from a customer. However, ordering funding can only finance transactions where margins are high (20% or more) and where you purchase the finished goods from a third party vendor.