What is Inventory Financing?
Inventory financing is a financing option that uses your business’s inventory as collateral to secure the financing. Typically, inventory financing takes the form of a line of credit or a revolving loan that functions similarly to a credit card. Inventory financing can be used to help you receive more inventory or more funds. If you end up with a line of credit, you’ll find it particularly useful when dealing with seasonal slumps.
When taking out inventory financing, your inventory is rarely taken for collateral at its full value since there’s no guarantee that the financing company will be able to sell it off if you default. For this reason, inventory financing tends to be more costly, specifically with rates, compared to other methods of financing.
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When considering your application for inventory financing, financing companies will offer your business a financing option based on a percentage of the value of your inventory, most often around 80%. This appraisal is not based on the market value of your inventory, but rather on the Forced Sale Liquidation Value (FLV) or the New Orderly Liquidation Value (OLV). The FLV is the amount of money a company will receive if it sold its assets immediately; it gives an estimate of the financial position of a company in the worst possible situation. OLV, unlike the FLV, accounts for not having to sell your assets immediately, but a company is given a reasonable time to find someone to buy them. This usually results in a higher value. The financing company uses these metrics because, if your transaction defaults, they will need to sell all off the inventory at once at liquidation pricing.
In addition to these requirements, the company you go through will ask for some of the same conditions that you might find in a business loan. While the credit requirements for inventory financing are typically a bit more relaxed, such as personal credit scores as low as 500, most financing companies do, however, require strong business credit histories. Your business plan will also be factored in to evaluate your riskiness as a borrower.
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Rates are 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 gives you a more accurate total cost of your financing.
APRs for inventory financing vary more drastically than most types of debt transactions. It can range anywhere between 9% to 55%, depending on many different factors. This rate doesn’t include any fees you may be expected to pay, such as draw fees, origination fees, or service fees. Inventory financing tends to have high APRs because of the added risk in the perceived value of the inventory in question. The inventory is evaluated not just on its current value, but also on its perishability and potential depreciation in value.
Some companies offer inventory financing without any credit requirements, which 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 there’s an increase in demand for sports cars, so a savvy dealer would take out a line of credit, via inventory financing, to purchase more sports cars, and pay off the debt as they sell.
For Retail Sales
Inventory financing is also ideal for small to mid-sized retailers. Larger corporate retailers have the stability and history to get lower-cost financing that smaller retailers may not qualify for. In this case, leveraging your inventory can help you create financial flexibility. Inventory financing can also help you build credit to make future financing more accessible.
Even though it might seem more expensive on paper, inventory financing can be cheaper than many other forms of alternative lending, but usually only after a certain price-point, given the high processing costs associated with this type of financing.
For Amazon Sellers
Amazon offers various types of financing options to its sellers, including inventory financing, although you can’t apply for yourself. Instead, Amazon uses an algorithm to decide which businesses get offered these, as well as what the terms and conditions will be. If Amazon contacts you with an offer, take some time to compare other options before accepting. Typically, Amazon will advance 80% of your income made on Amazon one day after making the sale at a cost for 2% of your sales. Inventory financing can be a good way to make the most out of a situation financially, but it really depends on your situation. Interest rates vary not only among lenders but based your business and the amount you need as well.
Before resorting to inventory financing, which can sometimes end up being costly, it’s always a good idea to check out other kinds of business financing to make sure you’re putting your business on the best financial path available.