Inventory Financing Do’s and Don’ts

Inventory Financing Do’s and Don’ts

Finance happens to be the lifeblood of a business. No business can survive without it. In order to have a business that has smooth operations and functioning, finance is required. There are numerous means to acquire finance for the business and loans are the most common modes of getting finance for the business. There is asset financing, asset backed loans, working capital finance and inventory loans.

Inventory financing is a short term loan that is made to a company so that it can purchase products and then sell them. These products/inventor tend to act as collateral for the loan in case the business fails to sell the products and thus unable to repay the loan.

For businesses that have to pay their suppliers in a short time period, inventory financing happens to be quite useful. Furthermore, inventory financing/inventory loans offers an ideal solution for seasonal fluctuations in cash flows so that business can increase their sales volume like getting extra stock/inventory during the holiday season for selling.

From a lender’s point of view, inventory financing is a type of unsecured loan because the business fails to sell its inventory the bank will not be able to either. This could partially but clearly explain the end results of the 2008 credit crisis. Numerous businesses found it quite complicated to obtain inventory financing.  The inventory that has been made or bought by your business to be sold is a worthy asset and the value of this inventory can be used for financing of your business without getting sold.

The concept of business asset financing applies to both accounts receivable assets and inventory.

Process of Inventory Financing:

For example, a dealer wants to increase the inventory and with summers approaching, there is a high possibility of increase in swimwear and summer apparel sales. The dealer has to buy the inventory from the designer/supplier/merchant. But buying in large amounts is expensive with a high demand expectation.

The dealer acquires a loan from financing company based on the value of the merchandise. When each of the dress/style is sold dealer pays off the portion of the loan that is directly related to that dress/style or could even buy more inventory to sell.

This defines the inventory financing step of the production cycle that includes buying, making and selling.  As inventory tends to depreciate in value, is cannot be converted easily in cash at its full value compared to accounts receivable so you will not be able to gain full value on your financing.

Do’s and Don’ts of Inventory Financing

There are certain dos and don’ts of inventory financing that you need to consider. If you are selling your inventory quite well and are in need of money to sell more, you might want to go for inventory financing. If your inventory has become out of date and you have a slow turnover , it would not be wise to attempt inventory financing as will not be able to find a willing lender for this.

Inventory Financing

Requirements of Inventory Financing

Like other forms of financing, a good credit record is required along with list of inventory and their values that you want to finance. Using the inventory valuation method of LIFO or FIFO you should be able to explain either method.

Furthermore, you need to have a business plan at hand so that you are able to show how you plan to use the proceeds of the loan and how you plan to pay it back. An estimate of how much you can borrow is given to you by the lender.  You need to keep track of your inventory while selling it in order to ensure it is in good shape. To ensure that the money is used rightfully, the lender has the right to inspect the inventory that it has retained its value.

Difference between Inventory Financing & Accounts Receivable Financing:

The amount that is owed to your business by customers (accounts receivable) are financed by being sold off to company that is called as factoring agent. The funds are collected by the factoring company and thus the loan is discounted considerably for the original receivable amount due to the cost and difficulty of collecting.

Why Inventory Financing?

For new ventures and startups, inventory financing could be quite helpful.  Readily available inventory stocks can boost your company as working capital can be difficult.  Small businesses who need to buy additional inventory or having cash flow issues could benefit from inventory financing.

Listed below are some of the benefits businesses can reap off of inventory financing:

  • For Seasonal Businesses:

Inventory Financing can be used for seasonal businesses for busy and slow times of year. Businesses that face seasonal spikes in customer demands like companies having holiday gifts could use inventory financing for purchasing more items in order to prepare for additional demand.  Similarly, companies selling seasonal products like swimwear could use the method of inventory financing so that in the slower months, they have capital at hand.

  • For Large Wholesalers:

Inventory loans can be used by large wholesalers to that they can keep additional stock of inventory in warehouses. Numerous big wholesales keep months’ worth of orders in their warehouse facilities and often come across the need to buy additional inventory so that large future orders can be fulfilled.  When wholesalers lack funds on hand, they need to restock the inventory and inventory financing is used to do so.

  • For Businesses with Stores & Storage:

To ensure that both stores and storage facilities are stocked with inventory, businesses use inventory financing. Customers may become frustrated and end their business with companies if their needs are not fulfilled when company fails to stock enough of a product of demand and sells out.

In order to avoid this situation, both physical storefront and online businesses use inventory financing so that they items are always available and inventory is well-stocked.

Inventory loans are a practical option for businesses that failed to achieve a traditional business loan. Since inventory can be used as collateral in inventory loans, businesses can make up for insufficient capital or credit history.

For further information on Corporate Loan Types, please visit here.

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