What is Inventory Financing?
Inventory financing is bank line of credit secured by the company’s inventory. This type of financing can help to free up some of the cash you have tied up in inventory for more pressing needs. Although not really available to pure startups as a track record of sales is required by the lender, the startup founder should be aware of this type of financing for later down the road.
Which Companies Should Use It?
Startups which can use inventory financing include:
- those with tangible inventory (in other words, service business need not apply),
- those with a proven sales history and good credit since lenders aren’t really interested in taking possession of your inventory if you can’t make your loan payments.
For this reason startups need not apply.
When Does Inventory Financing Make Sense for a Small Company?
Inventory financing makes sense when:
- when your company enjoys a high inventory turnover rate but is short of the cash needed to replenish its supply,
- your small business has a warehouse of goods ready to ship, but is short of cash to buy supplies for the next production cycle,
- when having to maintain high levels of inventory ties up much of your cash.
When is Inventory Financing Not Advised?
It’s not a good idea when you have either obsolete or hard moving inventory. Why add interest charges to your problems?
Tips for Getting Approved
- Demonstrate to lenders that you have a proper inventory management system in place which provides accurate and timely information on its size and cost.
- Ensure that the inventory is protected from damage and shrinkage by either the elements or people, respectively.
- Make sure your assets are maintained in good shape; your lender may require to inspect the inventory from time-to-time;
- Demonstrate to lenders that the inventory is actually selling by showing sales order.
- Show that you are managing your inventory as efficiently as possible by keeping the bare minimum on hand while maximizing the turnover rate.
Ingredients You’ll Need on Hand
You will most likely need to provide:
- an accounting of your inventory; your lender may require this to be audited or appraised by an independent third party,
- a basic financial package,
- an up-to-date business plan that shows your business is indeed on an upward growth spiral, indicating your ability to stay on top of loan payments,
- proof of sales orders showing that the inventory is moving,
- an additional form of collateral, such as a secondary position on a mortgage.
Drawbacks to Inventory Financing
Lenders will most likely need additional security in place to make sure that you are not disposing of the collateral improperly.
Most banks are not familiar with inventory financing which means that you will have to put in extra effort to find a banker who is comfortable with it.
The line of credit may have to be paid off in full every 12 months and then not used at all for one month.
If sales suddenly decline, two problems arise:
- you may have to unload your inventory at a loss, thereby undermining your ability to stay current on your line of credit, and
- the interest on the loan may sap your ability to keep production on schedule.
- high interest rates and other fees.
Creative Inventory Financing Solutions
You can learn creative inventory financing tactics from the AVC startup financing manual. These are advanced solutions used by elite Inc. 500 entrepreneurs and others.