What is 'Inventory Financing'

Inventory financing is an asset-backed, revolving line of credit or short-term loan made to a company so it can purchase products for sale. Those products, or inventory, serve as collateral for the loan if the business does not sell its products and cannot repay the loan. Inventory financing is especially useful for businesses that must pay their suppliers in a shorter period than it takes them to sell their inventory to customers. It also provides a solution to seasonal fluctuations in cash flows and can help a business achieve a higher sales volume - for example, by allowing a business to acquire extra inventory to sell during the holiday season.

BREAKING DOWN 'Inventory Financing'

Lenders may view inventory financing as a type of unsecured loan because if the business can't sell its inventory, the bank may not be able to either. This reality may partially explain why, in the aftermath of the credit crisis of 2008, many businesses found it more difficult to obtain inventory financing.

Inventory financing is a popular financing option for small to medium-sized retailers or wholesalers. Many small to medium-sized businesses lack the financial history or assets to secure more institutionally sized financing options that Walmart, Macy's, or Target regularly enjoy. Smaller wholesalers who might have a warehouse full of inventory have few options or leverage when approaching a bank for a traditional loan. Capital markets are not a prime financing source for small to medium-sized businesses; specialty finance companies often have the expertise and ability to work with smaller entities looking to pledge inventory as collateral.

As with any credit review, a careful and unique analysis goes into an inventory financing request. Banks and their credit teams will consider areas such as inventory market or resale values, perishability, theft and loss provisions, product demand, business, economic and industry inventory cycles, logistical and shipping constraints. In short, any potential hiccup is factored into setting an interest rate on an asset-backed loan. Not all forms of collateral are the same.

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