Stocking your shelves can be a challenge when so many other things are demanding your limited capital. Shiny new equipment needs to be purchased, employees need to be hired and trained, rent needs to be paid…here’s a seemingly never-ending checklist of expenses. With so many costs, it’s hard for small business owners to maintain adequate inventory.
When you have insufficient inventory, your business loses sales and misses opportunities to acquire new customers. But that doesn’t mean you should go and fill up every shelf with 24 months’ worth of product—you only have so much working capital. Your small business should strive to keep enough inventory to cover customer demand, but not too much that the expenses for buying and storing your supply financially debilitate your business.
How to Forecast Inventory Demand
There’s a magic Goldilocks-approved amount of inventory you should maintain: not too little, not too much. There’s a variety of forecasting methods to find the amount that’s just right. Let’s look at a few.
Passive Demand Forecasting
Passive demand forecasting assumes that if you expect no business changes (new products, expanded marketing campaigns, additional hires), then the demand will remain the same. If you expect to have an uneventful year ahead of you, it may be safe to assume your sales will remain unchanged. If that’s the case, then you know exactly how much inventory you need to have on hand: enough to satisfy last year’s demand.
Time-Series Analysis
If you have years of sales data to look at, time-series analysis can help you identify seasonal trends to pinpoint where demand rises and falls. For example, time-series analysis could help a clothing brand identify when customers start buying swimsuits, when they stop, and how much they usually purchase. With this information, the business will know when to invest in swimsuit stock, how much they’ll need, and when it’s acceptable to let the remaining inventory peter out.
Causal Forecasting
Causal forecasting is a more advanced forecasting method that businesses with years of qualitative and quantitative data can utilize. It considers several factors, including:
- Impact new marketing campaigns can have on sales
- External economic forces that’ll impact the demand
- Competitor’s products and marketing activity
And that’s just scratching the surface of everything that causal forecasting takes into account when estimating demand.
Pro Tip: There are also several inventory control methods that can help you maximize profits with the least amount of spend on inventory.
Inventory management software, like Sortly, can do the tedious work and alert you when stock levels are too high or too low — allowing you to make the most of your working capital, rather than having it tied up in unnecessary storage costs, excess inventory, and deadstock.
Benefits of Using a Business Loan to Purchase Inventory
Now that you have a ballpark inventory estimate, you’ll need to find the upfront cash to stock the shelves. Waiting to make sales to finance your inventory is a strategy for slow growth and missed opportunities. You need something with more leverage, more potential, and more flexibility: a business loan.
Here’s why you should consider using a business loan to finance your upfront inventory costs:
- You need money to buy inventory, but you need inventory to make money. No money, no inventory—no inventory, no money. A business loan helps overcome this paradox by giving you the upfront cash you need to build up your supply.
- When seasonal spikes are approaching, you’ll need extra cash to beef up your supply. If you fail to stock up adequately, you could miss out on sales. With a business loan, you can ensure your inventory satisfies the rising demand, regardless of how much cash you have at a given moment.
- A business loan helps prevent your cash flow from getting tied up solely in inventory. Running a business requires cash, and inventory is just one of many expenses.
7 Inventory Financing Options
There are several small business loans you can use to finance your inventory costs. Each has its pros and cons that make them ideal for different situations.
SBA Loans
In the wake of COVID-19, the Small Business Administration (SBA) is offering several different loan programs to help struggling businesses get back on their feet.
- Economic Injury Disaster Loan Program (EIDL)
Through the Economic Injury Disaster Loan Program, small businesses can apply for low-interest working capital loans of up to $2 million. According to the SBA, “these loans may be used to pay fixed debts, payroll, accounts payable and other bills that can’t be paid because of the disaster’s impact”. Interest rates for EIDLs are 3.75%, and terms extend up to 30 years in an effort to keep payments affordable.
- Paycheck Protection Program (PPP)
Of the $2 trillion stimulus package, $349 billion has been allocated to support the newly introduced Paycheck Protection Program. Administered by the SBA under their popular 7(a) lending program, this initiative offers small businesses zero-fee loans of up to 250% (or 2.5 times) your average monthly payroll with a flat 1% interest rate. And as long as you maintain your workforce, any portion of the loan you used for payroll and debt obligations will be eligible for forgiveness. There’s also no personal guarantees or collateral required, as these loans are 100% federally-backed.
Inventory Financing
Inventory financing is a loan you can use to purchase inventory. Because it’s an asset-based loan, the inventory is the collateral for the loan, decreasing the risk for the lender (meaning it’s easier to qualify for better rates and terms). Inventory financing is an excellent option for new businesses or those struggling to secure more traditional funding—like a term loan.
Unfortunately, there’s not a lot of flexibility with inventory financing. You use it to fund your inventory. That’s it. Plus, you’ll also be potentially subject to planned (or surprise) inspection visits from your lender to see if you’re correctly storing inventory to prevent damage or depreciation.
Pros:
- Higher potential sales volume
- Freedom to expand product lines
- Unlikely need for personal assets as collateral
- Easier to start back up from the low season
- Reduced cash flow issues
- Accessible with poor credit
Cons:
- Limited use of funds
- Potentially difficult to qualify for
- Higher interest rates than more elite forms of financing
Term Loans
If you want a simple, predictable way to finance your inventory, look no further than a term loan. A term loan gives you a lump sum of cash that you pay back (with interest) in recurring payments over a set amount of time. No fluff about it—just your classic loan. You get the benefit of predictable payments so you can forecast exactly when and how much inventory you need to sell to pay back the loan.
Pros:
- Lower interest rates than short-term borrowing options
- Reduced cash flow issues
- Flexible use of funds
- Predictable payment structure
- Bigger loan amounts
- Builds business credit
Cons:
- Higher credit requirements
- Newer businesses may not be eligible
- Potential fees
- Likely need a personal guarantee
Business Line of Credit
A business line of credit is one of the most flexible forms of financing. You can use your line of credit to finance just about anything, and you’re under no obligation to use it. That means you could secure a line of credit (just in case), and you may never even need to use it.
A line of credit is a foolproof financing option if you’ve faced unpredictable spikes in the past and aren’t sure how much additional capital you’ll need. Keep this financing in your back pocket to capitalize on vendor discounts or stock up quickly if the shelves start to empty unexpectedly.
Pros:
- Only pay interest on funds drawn
- Fast access to cash
- Flexible use of funds
- Reduced cash flow issues
- Accessible with poor credit
- Builds business credit
Cons:
- Extra charges and fees
- Potentially higher interest rates
- Low borrowing limits
- Fluctuating interest rates
Business Credit Cards
If you don’t qualify for traditional business loans, a business credit card can help finance your inventory costs. Getting approved is quick and easy. Plus, you can use your card on just about any business expense: inventory costs, warehouse rent, insurance, shipping expenses—you name it!
Pros:
- Earn rewards and perks
- Easier to qualify for
- Fast access to capital
Cons:
- Does not build business credit
- Higher interest rates than more elite forms of financing
- Potential fees and penalties
- Variable rates
- Likely need a personal guarante
Vendor Financing
Vendor financing is a great way to finance your inventory if you’re a new business with low or non-existent credit. Vendors often provide payment options to allow you to purchase inventory now and pay for it later. Depending on the vendor, they may give you 30 or 60 days to make your payments.
Pros:
- Higher potential sales volume
- Accessible with poor credit
- Reduced cash flow issues
Cons:
- Requires a solid relationship between the buyer and the seller
Short-Term Loans
Short-term loans are like term loans—just faster. If your inventory turns over regularly, it might not make sense to lock yourself into a 5-year term loan to pay for this year’s inventory. A short-term loan gives you quick access to capital that you’ll pay back over 6 months to 3 years. Short-term financing like this is a great way to fund inventory that flies off the shelves quickly.
Pros:
- Accessible with poor credit
- Limited paperwork
- Fast approval
Cons:
- Higher interest rates
- Higher annual cost
- More frequent payments can put a strain on your cash flow
Conclusion
You need money to make money. Fortunately, you don’t need a pile of bills sitting around to get your cash flow moving. Use these inventory financing options to free up your cash flow while keeping your shelves stocked.
Bio: Samantha Novick is a senior editor at Funding Circle, specializing in small business financing. She has a bachelor’s degree from the Gallatin School of Individualized Study at New York University. Prior to Funding Circle, Samantha was a community manager at Marcus by Goldman Sachs. Her work has been featured in a number of top small business resource sites and publications.
