What Is Inventory Financing?
Inventory financing is a revolving line of credit or a short-term loan that is acquired by a company so it can purchase products for sale later. The products serve as the collateral for the loan.
Inventory financing is useful for retail businesses that must pay their suppliers for stock that will be warehoused for some period of time before being sold to customers. It is particularly critical as a way to smooth out the financial effects of seasonal fluctuations in cash flows. It can help a business achieve higher sales volumes by allowing it to acquire extra inventory for use on demand.
- Inventory financing is credit obtained by businesses to pay upfront for products that will not be sold immediately.
- The loan is collateralized by the inventory it is used to purchase.
- Inventory financing is most often used by smaller privately-owned businesses that don't have access to other options.
Understanding Inventory Financing
Inventory financing is a popular option for small to medium-sized retailers and wholesalers. Such businesses typically lack the financial history and available assets to secure the institutional-sized financing options that are enjoyed by Walmart or Target. They are not generally public companies and cannot raise money by issuing a bond or a new round of stock.
Companies may also use their existing stock as collateral for a loan that is used for general business expenses. The purpose is the same: To keep the business' cash flow steady through busy and slow seasons.
Inventory financing is not always the solution. Banks 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. If a retailer or a wholesaler makes a bad bet on a trend, the bank could get stuck with the goods.
Some banks are wary of inventory financing because they don't want the burden of collecting the collateral in case of default.
Factors Banks Consider
This reality may explain why many businesses found it difficult to obtain inventory financing in the aftermath of the credit crisis of 2008. When an economy is mired in recession and unemployment rises, consumer goods that aren't staples remain unsold.
Banks and their credit teams consider inventory financing on a case by case basis, looking at such factors as resale value, perishability, theft and loss provisions as well as business, economic and industry inventory cycles, logistical and shipping constraints.
In addition, inventory of any kind tends to depreciate in value over time. The business owner who seeks inventory financing may not be able to obtain the full upfront cost of the inventory.
In short, any potential hiccup is factored into setting an interest rate on an asset-backed loan. Not all forms of collateral are equal.