Why Your Business Might Need to Take Out an Inventory Financing Loan
Even the most successful small businesses are known to encounter seasonal sales slumps, late invoice payments, sudden equipment breakdowns, and other circumstances beyond their control. As a business owner, you'll want to prepare by having access to extra working capital when situations like these put you in a tight financial spot.
Fortunately, there are lines of credit or short-term loans that are dedicated primarily to a business’s inventory needs. Read on to learn more about inventory financing and how it works. We’ll also talk about the advantages and disadvantages of inventory financing loans, the requirements to apply for them, and a few popular small business financing alternatives.
What is Inventory Financing?
Inventory Financing is a short-term loan or revolving line of credit made to a company to purchase products for sale. This type of small business loan is typically secured by existing inventory and does not require you to pledge any personal collateral. Your products, or inventory, will serve as collateral in the event that you cannot repay the loan.
Inventory financing is used to prepare you for those seasonal fluctuations, and allow you to stock up for your busiest season to fulfill large orders.
Types of Businesses That Can Benefit from Inventory Loans
Each business will have different inventory needs. For example, you might have to purchase a new line of products while another small business might need inventory financing to cover the costs of raw materials after receiving a massive order from a client. For the most part, the need for inventory financing is a good thing. It means your business is doing well enough that it has to prepare for the increase in demand or have sufficient stock.
Because inventory refers to product, only product-based industries will benefit from inventory financing.
Here are some examples of businesses that require inventory loans:
Retail stores include department stores whose product categories include shoes, clothing, jewelry, beauty products, and housewares. Specialty retailers specialize in a specific class of products such as toys, sports equipment, or lingerie.
Wholesalers are essentially warehouse retailers who stock up on a large variety of products packaged in large quantities which are sold at prices lower than retail. Because product moves in bulk, wholesalers require a lot of merchandise to store in their warehouses or other storage facilities at any given time.
Seasonal businesses may not enjoy a steady stream of customers or clients year-round. They do, however, experience an influx of demand in their products during specific seasons such as the holidays, the return to school, summer vacation, winter months, or even major sporting events like the Super Bowl.
Advantages of Inventory Financing
When it comes to making any financial decision, particularly when it involves taking out a loan, it’s best to weigh the pros and cons. Inventory financing comes with both. Here are the benefits of inventory financing for small businesses:
Allows you to meet customer demand
Seasons when your products are in high demand can mean that you may run critically low on inventory or worst, have to explain to customers that you’re out of stock. As a small business trying to build your reputation, the last thing you want to do is disappoint potential clients. Having access to a line of credit or capital dedicated to purchasing inventory can save your small business from not meeting customer demand.
No need for personal collateral
Other loans will require you to pledge personal assets as collateral. Knowing that there is always a risk of losing your home, car, and other assets under your name can make any business owner nervous. And you will feel this way until that last loan payment is completed! With inventory financing, the inventory you purchase is considered the collateral. In a worst case scenario where your business fails, you won’t lose your house, but you will give up all the inventory that was purchased using the loan.
Acquiring an inventory financing loan is a quicker process compared to other conventional loans. There is much less paperwork involved, and the loan usually gets approved within one to two weeks’ time provided you qualify and meet all the requirements.
No personal credit score required
Business owners do not have to worry about their credit score or lack of one when applying for inventory financing. Since lenders consider the inventory as collateral, they do not care much about your credit history. That’s why it’s possible to get inventory financing with no credit check.
Disadvantages of Inventory Financing
We’ve mentioned the specific types of business that can most benefit from inventory financing. Because there are different sorts of companies, this also means that inventory financing is not right for everyone. Here are some disadvantages you may want to consider:
Getting approval is tough
Yes, applying for an inventory loan is an easy and fast process; however, approval isn’t. Because the merchandise purchased will be considered as collateral, lenders will have to assess just how risky your business is. If they determine that you will have a challenging time selling your products, then that means they will have an equally hard time unloading the inventory in the event you can’t repay your loan, and they end up with it.
Lenders are more likely to approve inventory financing for product lines that have high-potential. As the business owner applying for the loan, you may have to work extra hard to prove that your products will sell.
Higher interest rates
Inventory financing typically comes with higher interest rates. Lenders feel they need extra security as there is no personal guarantee or collateral involved other than the inventory.
Because the lender must appraise the merchandise and evaluate your business, the setup costs are higher for inventory finance lines. The lender also must take into account the high operational costs that require regular appraisals which are typically done on-site by a specialized appraiser.
Am I Eligible for an Inventory Financing Loan?
Interested in how to get money for inventory so far? First, you’ll need to determine your eligibility. To qualify for an inventory loan so you can get money for your inventory, your business should meet the following requirements:
In business for at least a year
Your business should be a year old, at the very least. Your chances of approval are higher the longer you’re in business because it means you will have a more comprehensive sales history. A business that’s only just starting will have no previous sales records to show and therefore, it is very rare to hear about a lender approving a loan for a start-up.
Lenders will determine your eligibility based on your business’s previous financial and inventory records. For lender to process your loan application faster, you should prepare a detailed report of your sales history that includes everything from inventory turnover, profits, and sales projections. Your sales history must prove that your business is profitable and has the capacity to repay the loan.
Can provide a detailed inventory system
Lenders are particular about inventory control and product movement. They’ll expect that you can provide them with timely reports on the shipping and returns on products, accounts receivable or sale order receipts, and anything else that proves that you are monitoring and safeguarding the merchandise.
What Are the Steps Involved in Getting an Inventory Financing Loan?
As mentioned, applying for an inventory financing loan can be a faster process with less paperwork than some traditional term loans. In fact, some lenders allow you to submit your loan application online. However, they are still not the easiest type of business financing to get, and you do have to get your financial documents in order as the loan officer will need those to assess your eligibility and creditworthiness.
Here is a step-by-step guide on how to apply for inventory financing loan:
Step 1: Compile All Your Business Financial Records
The inventory financing lender needs a comprehensive look at your company’s financial standing. To provide them with one, you will need all the financial documents that show your assets, debts, profits, and losses. Future projections of your business’s growth are good to have as well.
A compilation of the following reports will serve as the starting point of the application process. Here is a list of the financial records you should have prepared:
How accurate are your balance sheets? The loan officer will want to see balance sheets for your business’s year-to-date operations as well as the balance sheets from the two prior fiscal years.
Profit & Loss Statements
A profit and loss statement or P&L is the financial statement summarizing revenues, costs, and expenses your business incurred during a specific period of time. They’re also known as income statements, statement of earning, statement of operations, or statement of income.
Your P&L gives the loan officer a clear picture of the net income of your business. This is important because the lender needs to establish if you’re capable of repaying a loan once you’re done paying all your expenses on a monthly, quarterly, or annual basis.
Business Bank Statements
Your business bank statements or account statement is a summary of your financial transactions that have occurred over a given period of time. In some cases, lenders might call your bank to verify your bank account and statements. Alternatively, they may fill out a verification of deposit (VOD) request form and send them to the bank to verify your account. Lenders need confirmation that the funds belong to you and that the source of the money is legitimate.
If you’re applying for a short-term loan, you may only need to provide at least three months’ worth of banking statements. The longer the term of the loan, the more banking statements from previous months you may need to provide.
Your inventory list shows the lender what inventory you have on hand and its approximate resale value. The lender will want to know the worth of your merchandise in the event of a default, and they are left to sell your inventory.
Inventory Management Records
Lenders will want proof that you can efficiently manage and maintain your inventory-related documents and files. The lender will want to see documentation on your past inventory such as the rate of turnover or the percentage of inventory that went unsold.
Remember that your inventory won’t just include what you already have but also involve the inventory you purchase with the funding. Therefore, the lender will want to see that you have a defined process for managing the new inventory that could potentially end up with them in the event of default.
While your business history is important to inventory financing, lenders are just as interested in your potential and the future of your business. Ensure your sales forecast is well-researched and shows that your company’s trajectory points upwards.
Business Tax Returns
Your business tax returns verify your revenue and determine your creditworthiness. Your returns over the last 2-3 years will establish a pattern and allow lenders to recognize the likelihood that you may default on your debt obligations. Or they may prove that you are worth the risk and worthy of credit.
Step 2: Complete Initial Application and Submit Final Documentation
Once you’ve gathered the necessary financial records and documentation on your inventory, you can complete a loan application form. As mentioned, some lenders have online application systems. The forms ask for basic information such as your name, business name, and the amount you are loaning. The financial documents you've prepared are either sent electronically or attached to the online application form.
Once the lender has determined that you have proven creditworthiness and are eligible for inventory financing, someone from the lending firm will contact you and will explain the “Due Diligence Period.” Due diligence is the investigation of your business that occurs prior to signing the contract committing you to inventory financing.
Step 3: Agree to Preliminary Commitment
Due diligence is a lengthy process for the person who is running the investigation. Because of the amount of work involved, many lenders will ask you to sign a loan agreement to lessen the risk that you decide not to follow through with the loan even after performing due diligence.
Step 4: Submit to a Field Audit of Your Business
Due diligence involves a field audit of your business during which a representative of the lender will meet you in person. They will want to visit your office space, facility or warehouse where you store your inventory. And of course, they will want to examine your existing inventory.
Step 5: Review Offer
Once you’ve undergone the initial review of your application and completed your financials, the lender will present you with a preliminary offer that details the loan or line of credit amount. Interest rates and terms are also included in the initial proposal. Take note that this is non-binding and not the final offer. It is a “preview” of the amount, terms, and rates and is meant to gauge your level of interest. If the preliminary offer interests you, the lender might ask you to pay a due diligence fee to show commitment and intention to proceed with the loan.
Step 6: Wait for Final Approval
Once your application is complete and you’ve shown commitment, you’ll have to wait for the final decision. You probably have a good sense at this point whether you are approved for financing or not.
Step 7: Sign Contract and Receive Funding
After final approval, you’ll have to sign some paperwork and the official contract that details the loan or line of credit amount, rate, and term. Once all the documentation is signed, you can typically expect the funds in a matter of days.
Can I apply for an inventory loan with no credit history or no existing inventory?
Inventory financing was created for small companies who are in business long enough to illustrate that their products are in high demand and result in high inventory turnover.
We’ve mentioned that the lack of credit history is a non-issue when applying for inventory financing since the purchased merchandise will serve as collateral. However, if you are a business with no existing inventory, convincing the lender why you qualify for an inventory financing loan may be challenging.
It’s not uncommon for a small business to grow and expand. A business that may have initially only offered services may want to introduce a product line at some point, as illustrated in their business plan. If this is the case with you, then you may have to convince the lender that your service-based business is profitable and influential enough to complement a line of merchandise. It’s up to you to get them to see the value and selling potential of your products.
Alternatives to Inventory Financing
While you may tick all the right boxes that say you’re qualified for an inventory financing loan, it’s still not the right match for every business owner.
There are times when other funding options may be the more favorable solution for your financing needs. Here are some additional options to inventory financing you may want to consider:
Term loans are the most conventional type of bank loan. You get a lump sum of cash upfront which you must repay with interest over a predetermined period. The downside of this type of loan is that a personal guarantee or collateral may be required. The upside is that you can use the cash for more than just purchasing inventory; you can also cover other costs related to your business that you don’t need to justify to the lender.
Business credit cards
If you’re thinking beyond inventory and need to finance ongoing expenses such as utilities, raw materials, and equipment, you can apply for a business credit card. This is a revolving line of credit that you can draw from and repay as needed for as long as you’re paying the minimum monthly payment and not exceeding the credit limit, just like a typical credit card. And just like most credit cards, they may come with high rates and extra fees.
Merchant cash advances
If your business has high credit card sales that are consistent, then merchant cash advances may be an ideal alternative for you if you can’t get financing anywhere else. Merchant cash advance gets your funds in exchange for a percentage of your business's daily credit card revenue. The MCA financing company will typically draw your company's repayments from your customers' debit and credit-card purchases on a daily basis.
One of the reasons why small businesses find themselves low on capital or inventory is because of slow paying customers. Waiting for invoices to get paid before purchasing inventory can mean that you’ll end up running dangerously low on stock. A method to get money for those unpaid invoices is through invoice factoring. A factoring company will buy your invoices, and they become responsible for collecting from your customers. This option is accessible to many businesses even with low credit or no credit, but it can be expensive in interest rates and fees.
Find our complete guide to invoice factoring here.
Invoice financing is similar to invoice factoring; except instead of selling your unpaid invoices, you’re using them as collateral to get a cash advance. This is a fast way to get funds, and a good choice if you want to maintain control of your customer relationships.
Purchase Order (PO) financing
Another alternative to inventory financing is purchase order financing. Purchase order financing allows you to finance inventory that associated with a specific purchase order. This works well for wholesalers who have large purchase orders but cannot fulfill them because they lack funds to purchase the merchandise. PO financing is also usually easier to qualify for compared to traditional bank financing. Read our full guide to PO financing.
Business line of credit - A small business line of credit is a financial tool similar to a business credit card. It offers the borrower access to capital up to a defined amount. And like a business credit card, you can access the capital as you need it to pay for business expenses such as purchasing inventory.
Business lines of credit are much more flexible than term loans which provide a lump sum of cash that follows a monthly repayment schedule.
With business lines of credit through Fundbox, the balance on your line of credit is revolving, meaning that you carry the balance month to month. The interest remains the same regardless of the amount you draw. As you repay the principal, available funds (minus flat transaction fees) replenish, allowing you to use your credit again, similar to using a credit card.
Financing with Fundbox
Thanks for reading our Small Business Guide to Inventory Financing Loans. Are you interested in financing your business? At Fundbox, we review data from either your approved accounting software, or your business bank account, in order to understand your company's business performance and potential.
We designed our online platform specially for entrepreneurs like you with small business financing needs who want to take the next steps to help their company grow.
If you own a business, you may qualify for Fundbox Credit™ up to $100,000. Sign Up Now and if approved, get your funds as soon as the next business day.