How Does an Inventory Line of Credit Work?

How Does an Inventory Line of Credit Work?

How Does an Inventory Line of Credit Work?

Business owners looking to increase cash flow for inventory might consider an inventory line of credit. This type of financing can work well for retailers, wholesalers, and seasonal businesses. In this article, we explain how inventory lines of credit work, how they’re different from an inventory loan, and which options are best.

How an Inventory Line of Credit Works

A business line of credit is a pool of money businesses can pull from as needed while only paying interest on the amount used. It’s also known as a revolving line of credit. Small business financing lenders may be willing to offer an inventory line of credit to a business with varying inventory business expenses. If your small business struggles to stay stocked during the busy season or keep up with customer demand, an inventory line of credit may help.

Here are the steps you’ll follow to open a business line of credit.

1. Calculate how much your total inventory will cost

First, do the math to figure out how much you’ll need to pay to restock your business’s inventory. This number will inform the lender how much they should offer you in funding. Line of credit lenders only cover a certain percentage of the total cost of the inventory, rather than the entire price.

An inventory management system can be helpful in calculating your business’s inventory turnover ratio. 

2. Find the right lender

Now it’s time to find the right funding option. If you decide to go with a line of credit rather than other small business loans, you’ll want to look into lenders that offer lines of credit. Some (but not all) traditional banks will, but many online lenders do have the capacity. 

When comparing options, look into whether or not there is a draw fee that some lenders charge every time you pull from the funds. Also, there may be fees for origination, annual service, and monthly maintenance, so check those as well.

3. Apply for the inventory line of credit 

The application process varies by lender. Many online banks offer easy digital applications. Whether you go with a traditional bank or online lender, they’ll likely evaluate your business and personal credit score, your time in business, and your annual revenue. Head to Nav’s guide for more on how to establish business credit.

4. Get approved and use the funds

Once you get approved, you can use the business line of credit to purchase products to stock your inventory. If there’s a specific draw period of time (explained below) for your line of credit, you may only be able to use funds during that time frame.

Keep in mind that interest rates may be higher with inventory lines of credit because it’s a bit riskier than other types of financing.

5. Pay back what you owe

Some financing companies have a draw period when you can access the funds and only pay back interest. Then there’s a repayment period when you’re required to make monthly payments on the line of credit until it’s paid in full over a certain period — usually six to 24 months for online lenders. 

Once you pay back what you borrowed in full, you can use the entire credit line again, as needed.

How Much Can You Borrow Against Inventory?

The loan amount on an inventory line of credit depends on the kind of inventory you have and the value of the inventory. Most likely, you won’t be able to borrow the full amount needed to purchase inventory. 

Typically, lenders offer a wide range of between 20% and 80% of the value of the inventory. And because inventory value can decrease over time, a lender may even use your inventory’s liquidation value (which in most cases is likely less than its purchase value) to figure out how much to offer you.

Is Collateral Necessary for Inventory Lines of Credit?

With an inventory line of credit, the inventory acts as collateral on the funding. So you don’t have to put down business assets or personal assets before getting an inventory line of credit. Although it’s nice to not have to offer collateral upfront, this also means that if you default on your payments, the lender can seize your business’s inventory to try to make back some of its profits.

What Is the Difference Between an Inventory Loan and an Inventory Line of Credit?

A line of credit is only one type of loan option you can get for the purpose of stocking inventory. Another common solution is a short-term loan from a bank or an online lender. Bank loans tend to have better repayment terms and lower interest rates than online lenders and give you a lump sum of money. 

On the flip side, term loans may be more difficult to qualify for and require better credit history and creditworthiness. Traditional banks also may be more reluctant to offer inventory financing because it comes with a higher risk than other types of financing. This is because you must sell the inventory to pay them back. They also usually take longer to send the funding while online lenders may send the funding as quickly as one or two days after applying.

What Are the Best Lenders Offering an Inventory Line of Credit? 

The type of loan your business needs depends on varying factors. But small business owners and startups have great financing options to choose from when choosing an inventory line of credit. Here are some of our favorites.

Also, keep in mind that business credit cards may be a great alternative for filling in cash flow gaps and allowing you to purchase additional inventory as needed. Create a free Nav account to see your best options for business credit cards. 

This article was originally written on June 30, 2022.

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