Director of Marketing, SortlyShahzad Karachiwala
Carrying enough inventory can be a make-or-break situation for many small businesses… which is why many businesses eventually consider securing inventory financing.
Inventory financing is a form of debt-based funding for businesses. The basic idea is that business owners receive money from a lender in order to purchase new inventory to sell. Companies built around selling products, whether retail or wholesale, know that cash flow issues are one of the most common reasons why small businesses fail. Sometimes bills are due before you have all the cash in hand from selling your last batch of inventory. That’s where inventory financing comes in handy.
The decision to take on debt in order to fund business operations is never an easy one. It should only be undertaken if the business finds that they simply can’t meet the demand of suppliers otherwise. Taking on that debt, and repaying it with interest, may help small businesses avoid the kind of cash flow mismanagement that doom many ventures.
While some businesses in this situation choose to pursue more traditional forms of financing, like a small business loan, inventory financing can be a more direct way of obtaining the funds you need to keep your business running.
Let’s review the six things you need to know before you decide that inventory financing is right for you:
Inventory financing is a relatively simple form of funding. Lenders that offer inventory financing will provide funds to borrowers specifically for them to use to buy necessary inventory.
During the approval process for your inventory financing loan, the lender will set a payment schedule for you to follow. Make your payments on time and in full, and you can freely sell and utilize your inventory however you’d like.
Fail to make your payments, however, and your lender can repossess the inventory you’ve purchased as repayment. They may also seize other inventory of similar value if they believe that inventory will better help them recoup the loan.
Small and medium-sized retailers and wholesalers are the most common types of businesses to use inventory financing. That’s because, unlike big retailers like Amazon or Target, they often lack the wiggle room and leverage with suppliers to avoid prompt payment—even if that payment is due before they offload all of their inventory.
Rather than take out expensive short-term loans to cover the cash flow gap, or sacrifice other areas of the business—laying off workers, for example—these businesses instead take up the offer of inventory financing, if they qualify.
Most loans fall into one of two categories: secured loans or unsecured loans. To “secure” a loan is to offer (or rather, be required to offer) collateral to the lender, such as real estate or equipment, that can be recouped to repay the debt in case of default.
Technically, inventory financing is a “self-secured” loan: The inventory purchased with the loan acts as its own collateral. Lenders, however, may consider it an unsecured loan if no additional collateral is put up—because if the business can’t sell their inventory, the lender may not be able to either.
The specifics of the loan or line of credit you receive from a lender offering inventory financing will depend on your financial situation, industry, and credit history.
To qualify for inventory financing, your business needs more than just possible collateral and the need for funding. Every lender is different, but here are the baseline qualifications:
The exact costs of your inventory financing will depend on the kind of product your lender offers. You may receive a standard loan from a traditional lender, a short-term loan from an online lender, a line of credit, or financing directly from the vendor selling you the inventory.
Other factors will also determine your interest rate, APR, and service and origination fees. Your time in business, business credit report, and potential collateral all affect your overall costs.
When comparing the costs of different inventory financing options, be sure to use APR—annual percentage rate—to ensure an apples-to-apples comparison.
There are some clear and obvious advantages to inventory financing if you decide that’s the right move for your small business, including:
No form of financing is perfect, of course. Here are the drawbacks associated with inventory financing:
Now that you are armed with extensive knowledge of what inventory financing is and how it can work for you, it’s time to gather up your important and relevant financial documents, find potential lenders, and start the application process.
Inventory financing is just one of many kinds of business funding available to established small businesses. Using debt-based financing to grow your business is a common tactic that can deliver a good return on investment, so don’t be afraid to explore this possibility. Just be sure to take the time and research all of your options—plus, talk to your accountant or other financial advisors—before you move ahead and apply.
This guest post was written by Eric Goldchein in partnership with Fundera.
Eric Goldschein is a staff writer at Fundera, a marketplace for small business financial solutions such as business loans. He covers entrepreneurship, small business trends, finance, and marketing.