Spend less time applying for loans and more time tunning your business.
What is Inventory Financing?
Inventory financing is a line-of-credit or short-term loan which uses a business’s inventory as collateral. These loans can be used to help procure more inventory or for working capital. They are particularly useful when dealing with seasonal variations, like a shop which needs to get more inventory to sell for the holiday season.
Inventory is rarely taken as collateral at full value, based on the idea that if the borrower’s business fails to sell the inventory, then the lender probably won’t be able to either. For this reason and others, inventory financing is more costly than many other forms of funding, so other means should be explored first.
Lenders offer borrowers a loan based on a percentage of the value of the inventory, most often around 80% of the appraised value. The appraisal is not based on the market value which a retailer would have to pay for, but rather on the Forced Sale Liquidation Value (FLV) or the New Orderly Liquidation Value (OLD). The lender uses these metrics because if the loan defaults the lender will be in a position that they need to sell all of the inventory at once, selling from this weaker position means the lender will likely get much less than market value for the inventory.
In addition to these requirements lenders also ask for some of the same conditions typical of a business loan. While the credit requirements for inventory financing are typically a bit more relaxed, most lenders ask for good business and personal credit. The lender will factor in the business plan of the borrower to assess the risk of the loan defaulting.
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Rates can be measured in two ways, Annual Interest Rate, and Annual Percentage Rate (APR). The APR takes the Annual Interest Rate and adds all other fees. While both are important, the APR of a loan gives you a better sense of its true cost.
APRs for Inventory Financing vary more drastically than most types of loans. It can be as low as 9% or as high as 55% depending on the lender and the circumstances. Inventory financing tends to have higher APRs than other secured loans because there is an added element of risk in the value of the inventory. The inventory is assessed not just on current value, but also on perishability and potential for loss in value. For example, an inventory loan to an electronics store will have to factor in the possibility that the computers in the inventory to become obsolete if the borrower defaults two years later. Other forms of inventory have a more stable value and are therefore lower risk.
Inventory financing also carries a much higher due diligence cost than other loans. In a conventional loan, a house may be used as collateral, and the lender assures a fair appraisal by doing a house inspection and checking the house against similar homes selling in that area. To assess the value of a business’s inventory the lender must be inspected to see if the count on the inventory is correct, if the inventory is in good condition and is well stored, as well as a value appraisal of the different items in stock. The added complication of this process costs money, and that cost is reflected in higher APRs (especially for smaller loans).
Some lenders offer inventory financing without any credit requirements. While these loans are easier to qualify for they also typically have higher APRs.
For Auto Sales
Inventory financing can be a useful tool for auto dealers. If you have reason to believe there will soon be an increase in sales you can use inventory financing to buy more cars from a manufacturer and use these cars as collateral. For example, every spring you notice an uptick in sports car sales, so you take out an inventory loan to buy more sports cars, and as you sell them, you pay off the debt.
For Retail Sales
Inventory financing is ideal for small to mid-sized retailers. Larger corporate retailers like Walmart have the stability and history to get lower cost loans. While smaller retailers may no qualify for other loans and need to use their inventory to gain financial flexibility. Inventory financing can also help establish good credit to acquire a lower cost loan in the future. While more costly than other secured loans, inventory financing can be cheaper than many other forms of alternative lending. However, it should be noted that the high cost of due diligence for this type of loan will reflect more on smaller loans, so it might only be a worthwhile option for loans of over $500,000.
For Amazon Sellers
Amazon offers various types of loans to its sellers, including inventory financing. However, you cannot apply for these loans. Amazon uses an algorithm to decide which businesses get offered loans, as well as what the terms and conditions of the loan may be. If Amazon contacts you with an offer of a loan, take some time to compare other options.