Inventory financing is among the many ways in which you can secure funds to grow your business.
In addition to checking your business credit report, company history, and other details to determine whether your company qualifies for financing, most lenders will want to see what you can use as collateral to guarantee the loan. These assets give lenders assurance that you can repay the loan amount via a second source of potential value in the event your first source isn’t sufficient.
In this respect, inventory financing is similar to getting a mortgage for your business’s storefront or office space. A lender gives you funding to purchase an asset, but instead of the asset being a storefront, it’s your business’s inventory. Instead of your storefront serving as the collateral, your newly purchased inventory becomes the collateral. Your goal is to sell those products to repay the loan. In the event you cannot make your payments, the lender takes ownership of that inventory.
The Benefits of Inventory Financing
This form of financing is particularly helpful for startups. Not only can it be used to purchase actual products, but it can go toward buying raw materials to create products. When a business is starting out, it may not have the funding necessary to stock its shelves and handle the many other expenses that come with getting a company off the ground.
Inventory financing is also particularly helpful for businesses like retailers and wholesalers. These businesses can have a high level of perceived risk in the eyes of a bank, and a loan of this nature could be less costly than seeking a loan from a non-bank lender.
Inventory financing can be used to restock merchandise before an upcoming busy season. Prior to the holiday shopping season, for instance, some businesses may go through a slump and lack the funds necessary to replenish their products before consumers are ready to shop. Companies can get loans for their merchandise, rack in holiday sales, repay their loan amounts and pocket whatever’s left.
The Challenges of Inventory Financing
While this option may appear attractive to business owners, lenders identify pitfalls to inventory financing and often consider this a form of an unsecured loan. You get the funds with the expectation that you can sell the merchandise within the prescribed repayment period. However, if you cannot, there’s no guarantee the lender will have success selling the products either.
Given the amount of risk lenders assume, certain products will not be eligible for financing. Businesses whose products are eligible might face a high cost to financing because of the assumed risk. Lenders may require regular reports on the values of some inventory to ensure it can be sold at a price sufficient for loan repayment.
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Inventory financing can be a good short-term loan option for businesses expecting a surge in demand, but be sure to evaluate other options before settling for a loan that is less than optimal for your business. A business line of credit from a bank or a vendor with whom your business has a solid relationship could prove to be less expensive and easier to obtain.