Inventory Financing

Inventory financing is a type of asset-based lending that relies solely on the inventory that a business can offer, including current and future inventory, as collateral to secure a loan for inventory purchasing. With asset-based lending programs, businesses can utilize other assets, in addition to inventory, or just use standalone inventory in order to secure financing. Businesses that are in B2B, or business-to-business industries are able to use inventory, accounts receivables, and equipment as collateral, whereas B2C, or business to consumer industries will only have inventory or potentially equipment available to offer as collateral. In either case, using the inventory that a business has available as collateral for a loan can help a business owner improve their cash flow for operating expenses or growth opportunities.

The amount of money that a business can borrow against their inventory varies depending on the industry that the business is in, the inventory churn, and the type of inventory that they have to offer as collateral. It is common for businesses to work with inventory in three separate categories: raw materials, works in progress (WIP), and finished goods. While all three types of inventory have value and are assets on the balance sheet, not all types of inventory are appealing to inventory lenders, and not all types will secure enough financing for working capital needs. The key component to evaluating the value of the inventory that a business has in stock is going to be the ability for a third party to sell that inventory in the event that the business is not able to pay back the loan at any point during the terms of the deal. Raw materials are generally very easy to liquidate, which makes this type of collateral an appealing form of inventory for inventory lenders to consider for collateral. As long as there is a market for the sale of the inventory products, finished goods inventory can be an attractive form of inventory to use as collateral to secure inventory financing. However, work in progress or WIP inventory is usually not valuable to asset-based lenders or inventory lenders. This is normally the case because work in progress inventory is usually sold for just the melt-down or material value of the products, which could be valued at only pennies on the dollar, depending on the type of product. Business owners can learn more about inventory financing programs by speaking with a Lending Advisor today!

Like all forms of asset-based lending, inventory financing is a great way for business owners to unlock cash that is otherwise sitting on their balance sheets. Valuable inventory provides asset-based lenders with comfort when cash flow alone can’t support a business loan. Especially for business owners that keep their shelves stocked with valuable inventory or experience a high turnover for their inventory, inventory financing provides an additional funding option for business owners that need a boost in working capital. Smart business owners know how to utilize multiple financing products and funding plans in order to maximize the efficiency and working capital available at any given moment. By capitalizing on inventory financing for inventory purchasing, additional funding options and credit lines remain open and are available for future use. The liquidity provided by inventory financing gives an added amount of flexibility to businesses.

A major benefit of inventory financing is that the terms of this type of lending product are frequently structured as revolving lines of credit. This means that principal and interest payment are due when inventory churns or is sold and as payments are made on the loan balance, the amount of money available goes back up. Having an inventory line of credit will provide business owners with the ability to unlock tied up cash and not make any amortizing payments. Without monthly payments, business owners that take advantage of inventory financing have an immediate increase in cash flow by capitalizing on their valuable inventory, whether it is the inventory currently sitting on their shelves or the inventory that they will buy in the future.

Another benefit of inventory financing is for businesses that frequently need to buy new inventory, but run into cash flow shortages. By capitalizing on inventory financing, business owners can make expensive inventory purchases, using the value of the new inventory itself as collateral to secure the funding. Once that inventory is sold, the business can pay back the money owed to the lender. This allows business owners to keep their shelves stocked with the inventory they need to maintain their business operations, even when cash flow is short.

Because the value of the inventory that a business wants to purchase acts as the collateral to secure funding for the inventory financing itself, the inventory itself is the asset being used to back the borrowed funds. Although this opens the doors for many business owners that might not qualify for other traditional loan options, it does often make the process to apply for inventory financing document-intensive. Specifically, there is a substantial amount of documentation required to evaluate the inventory and determine how much money will be available for the specific inventory items. Often, a lender that offers inventory financing will use field audits and inventory valuations as a part of the funding process. The field audit is an important component of inventory financing, as this process determines the final approval and funding availability will be for their inventory financing line of credit. During the field audit, the lender, or a representative on their behalf, will visit the location of the inventory in order to evaluate the value of the collateral that will be used to secure the funds. This audit will determine how much money the lender will offer for the inventory as collateral, usually based on the amount that the inventory could be sold for in the event that the borrowing business cannot repay the funds. After the reports are received and the final approval is issued, typically the borrowing business is able to borrow up to 80% of the appraised value of the inventory.

The first part of the underwriting process consists of the lender reviewing financial documents from the borrowing business. Some of these documents include: Profit and Loss statements, Balance Sheets, A/R and A/P Aging report (accounts receivable and accounts payable), inventory reports, business tax returns, and future projections. Once these documents are received by the lender and a business is approved for inventory financing, the borrowing business will receive a term sheet to outline the inventory loan amount, the advance rate, interest rate, and any associated fees. When the borrowing business owner accepts and signs the term sheet, they will have to make a deposit for a field audit and diligence, which begins the process to evaluate the inventory and determine the amount that can be borrowed.

Typically, inventory is the main asset used as collateral to secure funding from a lender for inventory financing. The type of inventory that a business has to offer, the ease of liquidation of that particular type of inventory, and the location of the inventory all play a major role in determining the advance rate or LTV for an inventory loan. For example, if a company that manufactures its own jewelry were using the jewelry that’s a finished good as the collateral to secure funding for inventory financing, they might receive a 30% LTV from a lender, which is not considerably high. The reason that the LTV is low in this example is because the jewelry is already a finished product, the materials most likely will not be reusable, so there is less value in the product from a liquidation stand point. However, a steel manufacturer that holds raw steel as inventory that can be used in different ways by different businesses might receive a 65% LTV, because the raw material is more likely to be resold or liquidated than finished products. From a lender’s perspective, the faster, easier, and higher value that they can sell the inventory pledged as collateral, the higher the value they will assign and the more money they’ll advance to a borrowing business’ inventory.