Small business owners that need working capital to buy inventory but don’t have assets to put up as collateral may be overlooking one potential resource that can help: the inventory you want to buy. In this article, we’ll cover what you need to know about inventory loans for your small business.
What Is an Inventory Loan?
An inventory loan, or inventory financing, is short-term business funding that allows you to purchase products for your small business. It can be a loan or line of credit.
With inventory financing, the supplies, materials, or products you’re buying act as your collateral, which secures the loan. Inventory short-term loans and lines of credit are designed to provide fast access to cash flow to purchase inventory.
How Do Inventory Loans Work?
Lenders offer inventory loans to borrowers who want to buy inventory or add to their product lines but don’t have enough cash on hand to cover their business needs. They are usually flexible short-terms loans or lines of credit that can be used for inventory purchases.
You may only be able to borrow a portion of the total cost of the inventory you need. Typically you can borrow about half of the value of the inventory, so you’ll still need to be able to pay for the rest.
The inventory serves as collateral, which means your loan is secured by the inventory you’re purchasing. So if you are unable to pay off the loan, the lender has the ability to seize the inventory to cover your debt. You’ll repay your loan like you would any other, with monthly payments of up to a year that include fees, interest, and principal defined by your repayment terms. Inventory loan rates may be higher than interest rates for other types of financing like traditional bank loans. But the loan application process is usually easier and funding is faster.
Pros and Cons of Inventory Financing
There are benefits and drawbacks to consider with any type of financing before applying. We highlight the most important things to note about inventory financing below.
The main benefit is that inventory loans get you the capital you need to cover business expenses related to inventory purchases fast. If you took out a loan with a traditional bank, it could take weeks or months for your application to be approved. Inventory financing happens quickly.
The inventory you buy can help you boost your business during a slow season when you might not have cash on hand to make inventory purchases. Then you can repay the loan during your busy season.
Another perk is that it may even be easier to qualify for inventory financing options. If you don’t qualify for other types of financing, you may qualify for inventory loans. So if you run a startup that’s been turned down for a bank or SBA loan because of your lack of creditworthiness, know that this may still be an option.
The first drawback to consider is that you may have a higher interest rate with inventory loans than you would other types of business loans. If you qualify for lower rates with traditional bank loans, it may be smart to consider those first.
Also, inventory loans typically are short-term and must be repaid within a year. If your budget can’t accommodate this monthly expense, you could end up in hot water.
What Are the Types of Inventory Financing?
There are several lenders that offer different types of business inventory financing to consider.
Inventory Line of Credit
If you aren’t looking for a lump sum of cash to buy inventory with, consider a business line of credit. You are approved for a certain credit limit — and you can borrow up to that full amount and repay it. This ability is useful if your inventory purchasing needs fluctuate throughout the year.
Some financing lenders specialize in inventory factoring. In this case, you sell your purchase orders or accounts receivable to purchase the inventory you need to fulfill the order. The lender takes a fee.
Alternatives To Inventory Financing
Inventory financing may not be your only option to get the money you need for inventory. You may also be able to use business loan options to meet your financing needs. These options include:
Business Line of Credit
A business line of credit offers flexible short-term financing. You get approved to borrow up to a certain amount (your credit limit) as often as needed.
Small business loans are often short term, meaning you must pay them back within a year or two, depending on the loan terms. The interest rate you get may depend on your personal credit scores, your business credit scores, or a combination of the two.
Business credit cards can be another way to financing inventory. They offer a line of credit you can use to purchase inventory, office supplies, or other items you need for your business and.
Merchant Cash Advance
While it’s not a type of loan, a merchant cash advance may be able to help you get the new inventory you need if you don’t have great credit and can’t qualify for other financing options.
Where to Get an Inventory Loan
There are online lenders that specialize in inventory financing. Start by asking for recommendations from others in your industry. Banks are less likely to offer inventory loans.
Nav can help with personalized options your business may qualify for based on your business data.
Inventory Loan Options
Here are lending that can help you finance inventory and other business needs.
How to Apply for Inventory Financing
Applying for inventory financing will typically involve the following steps:
- Find the type of financing you want to get, and the lender or financing company that offers that type of financing.
- Fill out an application online, in person or on paper. (May loan applications are available online today.) Include details about your business, and any additional documentation requested such as financial statements like balance sheets or profit and loss statements, and/or business bank account statements.
- Wait for a decision. Many online lenders can approve or decline and application in as little as 1—3 business days.
- Get funding. Typically funds will be deposited into your business bank account.
What To Consider When Choosing An Inventory Loan
Cost is one of the most important factors retailers need to consider when evaluating inventory loans. The cost of financing eats into any profits you’ll earn from the sale of that inventory and if your profit margins are thin, you could lose money by financing that purchase.
Another factor to consider is your inventory turnover ratio. The longer it takes to sell your inventory, the more costly that financing will be. Again, that cuts into your profit margins.
There is always the risk that you can’t sell the inventory. If customer demand doesn’t meet your expectations, you may find yourself sitting on inventory that you must discount heavily. And that also means you can lose money.
Finally, you want to consider how quickly you can get the financing you need to purchase inventory. If you run a seasonal business, for example, and it takes weeks to get funding you may miss out on your window to sell that merchandise at a profit.
What Is the Best Way to Finance Inventory?
The best way to finance inventory is to find a financing company that offers terms you are comfortable with. Consider the fees or interest you’ll pay and how quickly you will have to pay the loan back.
Do your homework to find out how the company fares in terms of customer service. You don’t want to get a loan with a low rate if you can’t ever get customer service on the phone to answer questions.
If you are able to pay the loan faster, can you save money, or is there a prepayment penalty? Ask plenty of questions before landing on a lender.
How Much Is the Cost of Financing the Inventory?
Just like any small business loans, inventory financing options come with a cost. Most charge interest, and depending on your business and personal credit, those rates can vary wildly. The better your credit, the lower the rate and the converse is true as well. If your credit scores are poor, you’ll pay a lot more to get the loan.
How to Qualify for Inventory Financing
Before applying for an inventory financing loan, check your business and personal credit scores. If you don’t have a business credit history, lenders may look more at your personal scores, so make sure you are at least aware of your personal credit scores.
Unlike bank loans that require collateral, you typically won’t have to pledge personal assets for the loan, nor is a personal guarantee required. However, the inventory may serve as collateral for the loan. You may be asked to provide order details on the inventory you’re looking to buy so the lender knows the value and can determine how much to lend you.
How to Get Inventory Financing
The application process for inventory financing works differently with different lenders, but typically doesn’t require much more than a few details about your business, how long it’s been in operation, and your annual revenues. You may be asked details about the inventory you’re looking to purchase as well.
Based on the value of the inventory you want to purchase, the lender will determine the amount of money it will lend you. If approved, you’ll sign the loan agreement, which includes your loan amount, interest rate, and repayment schedule. Your funds will be deposited into your business bank account in as little as a day.
Nav’s Verdict: Inventory Financing
If you don’t have the capital to purchase products or raw materials on hand, it’s nice to know that there is small business financing like inventory loans and lines of credit to help. Nav is always here to answer your questions about the world of inventory financing and loans.
Frequently Asked Questions About Inventory Financing
What is the Difference Between an Inventory Loan and an Operating Loan?
An operating loan is a term that may be used to describe a few different types of financing. It may be used to describe a loan a business obtains to meet short-term needs while operating in a down cycle, or it may describe a loan used to finance operating expenses. An inventory loan is used specifically to finance inventory. So while there may be some overlap between the two, the inventory loan has a very specific purpose.
What is the Difference Between Inventory Financing and Inventory Factoring?
Inventory financing describes a loan or line of credit used to purchase inventory. Inventory factoring describes financing where you sell your purchase orders or accounts receivable to purchase the inventory you need to fulfill the order.
This article was originally written on December 21, 2021 and updated on April 26, 2023.