What is Inventory Financing?

It’s pretty normal to have a small business of your own and then find yourself running a little low on operational cash. Perhaps you underestimated how much of a cash cushion you need, or maybe some projected expenses were much more expensive than you thought it would be. Sometimes the competition can crowd you out, or maybe a customer you depended on to pay on time suddenly failed to do so.

When these things happen, most small business owners tend to think about getting a traditional bank loan. But these days the odds of actually getting a loan from a bank aren’t all that good. This is especially true if you don’t have any collateral to offer as security for your loan.

In a way, inventory financing is a form of secured business loan, even if you may currently not have any inventory to speak of.

How Inventory Financing Works

With inventory financing, you get either a short-term loan or a line of credit, which you then use to buy the inventory you need. These products are the inventory, and they serve as collateral for the loan. In other words, if you’re unable to pay the loan according to the agreement you drew up with the lender, the lender then has the right to seize this inventory as part of the payment.

Often, the reason you’re unable to pay for the loan is because the inventory you’re supposed to market and sell isn’t selling as well as you expected. According to experts, this makes inventory financing a form of unsecured loan. After all, if your business is to sell these items and you fail, then how is a bank supposed to succeed where you didn’t?

However, if the inventory is selling well, the money generated by the sales is then used to pay off the loan. For example, let’s say that the lender advances you $100,000 to buy gadgets at $5,000 each which you can sell for $10,000. You can then use the money from each sale to pay off part of the loan or use that money to get more inventory.

In the end, you pay off the loan plus the interest or the cost of the cash advance. Usually, the cost of this form of financing is greater than what factoring entails because of the greater risk and uncertainty. With factoring, items have already been sold, but in inventory financing this is merely hoped for.

Should You Use Inventory Financing?

It depends on the marketability of your inventory. If your inventory is selling well, then you can use inventory financing to reap more profits for your business. However, if your items are not selling well, then lenders may find them unsuitable as security for the loan.

To get inventory financing, you usually need a good credit record and a viable business plan, along with the inventory (and the values) you want to finance. The lender will then offer financing based on the realistic expectations of sales and profits from the inventory.

As the recipient of the loan, part of your responsibility is to make sure that your inventory is in good condition. Lenders have the right to inspect the property to certify that it retains its value as collateral.