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Small business owners who sell products to generate revenue may find themselves in need of an inventory loan if they’re short on cash. Without the capital to buy inventory, many find themselves stuck without a way to generate revenue. Inventory loans are small business solutions that make it possible for a business to buy inventory and pay back the credit as the products are sold. Small business inventory loans allow a business to continue to sell products, even if it can’t afford to buy them outright. Read on to learn more about how inventory loans work, inventory financing companies, as well as the advantages and drawbacks.
What is an Inventory Loan?
Just as it sounds, an inventory loan does not require you to put up your car, business equipment, or home as collateral. Instead, you use the inventory you plan to buy to secure the funding. If you cannot make the payments for the loan, the lender will take the inventory that has not yet been sold to cover the outstanding debt.
Remember: An inventory loan cannot be used to buy anything other than inventory. If you need your loan to cover any additional purchases or equipment, you should apply for a regular business term loan or line of credit from another lender.
Terms for financing inventory loans
The interest rates, applicable fees, and terms for repayment differ among inventory financing companies. Terms, however, usually stipulate:
- You can borrow an amount up to the total liquidation value of your inventory. However, inventory financing companies that provide small business inventory loans typically finance 50% to 80% of that amount. Therefore, in many cases, you cannot borrow the full amount of the collateral.
- Most loans range from 3 to 12 months long.
- The annual percentage rate or APR can vary widely, from as low as 4% to as high as 90%. The rate you receive will be based on the lender, your creditworthiness, and the funding terms.
- Inventory financing companies may include fees, such as an appraisal fee to calculate an inventory’s value, origination fees, or prepayment penalties. If you’re familiar with credit card processing fees this will not be drastically different for you.
Inventory financing companies provide inventory funding as a business line of credit or term loan. This means the business receives the money in one lump sum.
Therefore, inventory loans represent a type of debt-based funding. This means you’re receiving from a lending source where you agree to repay what you borrow, including interest, over time. While the inventory serves as collateral, some inventory financing companies may also require a lien on a company’s assets. They may also ask the business owner to provide a personal guarantee.
Lenders issue inventory loans as a form of short-term financing. Therefore, they expect you to borrow the money to buy the inventory you need so you can sell it and quickly repay the loan. They really do not want to see your business still repaying the loan long after you have sold the inventory.
Basic examples of how the loan works
Let’s pretend you have just applied for inventory financing. You can either receive the funds in a lump sum or as a line of credit. You will pay back the lump sum with interest over a term, such as 12 months. For the line of credit, you will draw a specific amount against it when you need to buy inventory. Assuming you have taken out a revolving line of credit, you will repay the amount you owe until the credit limit returns to the original amount approved for the financing. Unlike term funding, you will only pay interest on the part of the credit line you use.
For example, let’s say you finance a small amount for a term loan – $50,000 for inventory. The online lender decides that the liquidation value for your inventory comes to $35,000. They agree to lend you $28,000, or 80% of $35,000 at an interest rate of 10%.
In this case, if you use the whole $28,000, and make 12 payments over a year, you would repay $30,200, or $28,000 plus $2,800 in interest. The monthly amount over 12 months would be $2,567 (rounded up).
If you use a line of credit that covers $28,000, you might, for instance, use $5,000 to make inventory purchases. In this scenario, you will still have an available credit balance of $23,000. Once you pay back the amount you withdrew, including interest, your balance returns to $28,000.
What Are the Benefits of Small Business Inventory Loans?
You will find small business inventory loans offer you a number of advantages, namely:
- You do not have to use your personal or business assets to secure the loan, reducing professional and personal liability
- Once the lender approves the loan, you should receive the funds relatively quickly
- You don’t need to have perfect credit to apply for the financing
- Small business inventory loans give newer businesses a chance to receive funding after only being in business a short time
- The loan allows you to quickly buy inventory so you do not miss out on discounts
- Inventory loans give you the latitude to cover peak seasons while taking advantage of sales
- You can free up the cash tied up in your company’s inventory
To offset these benefits, you still have to remember you probably won’t be able to borrow the total needed to buy your company’s inventory. Some of the lenders that provide inventory financing require that you apply for a minimum amount, which may be sizable. Some can be as much as $500,000.
Businesses That Often Utilize Inventory Loans
Businesses that frequently apply for inventory loans are small businesses including restaurants, retailers, and wholesalers. These businesses normally have a high enough sales volume to pay back the debt. They only have a single funding need, given the nature of their operations.
Restaurants use inventory loans to restock shelves of perishables or stock that frequently need to be resupplied. Therefore, inventory financing helps a restauranteur cover these types of purchases for a short-term or medium-term period. For a restaurant, inventory financing can be likened to equipment financing, except the supplies sit inside a pantry or refrigerator.
Whether you manage an eCommerce store or a brick-and-mortar location, you can help meet customer demand by taking out an inventory loan. This type of funding gives retailers access to the capital they need to buy inventory in a fast-growing sector.
In turn, a retailer can stabilize its cash flow and meet the demand of fluctuating sales cycles and revenues. Most importantly, an inventory loan helps retail businesses keep their shelves stocked, meet customers’ needs, and expand the business.
Wholesalers and distributors
Wholesalers and distributors use inventory loan funding to:
- Fund rapid growth
- Generate cash flow to balance out seasonal sales
- Borrow the money when they have reached the funding ceiling with their bank
By taking out an inventory loan, wholesalers, in particular, can replenish their inventory while generating more sales and profits. This advantage allows them to negotiate better terms with the businesses that use their services.
What Are Other SMB Loan Options
Besides inventory loans, small-to-medium business (SMB) financing options may include the following:
- Regular term loans and business lines of credit that cover inventory, equipment, and other business needs.
- Business credit cards designed, primarily, to take care of inventory and business supplies.
- Merchant cash advances: An advance for capital that a provider deducts as a percentage of a business’s credit or debit card sales. The repayment period ranges from 3 to 12 months. This form of financing is ideal for businesses that process a large volume of credit card transactions.
- Accounts receivable financing allows a company to receive early payments on outstanding invoices. By using this type of funding and paying a fee, a business commits part or all of its outstanding invoices to a lending source for early payment.
Before you commit yourself to a specific type of financing, learn more about the features of the various financing options. Take into account factors, such as the borrowing limits, repayment terms, interest, type of collateral, and fees.
A personal guarantee legally binds the person making it, thereby making them responsible for a business obligation. Check to see if this type of guarantee is included with the financing.
What to Do Prior to Contacting Inventory Financing Companies
Before contacting inventory financing companies about their loans and terms, you will need to prepare. For example, you will need to create a budget and calculate how much you will need to borrow. This must be done in advance, or inventory financing companies won’t be able to help you.
Create a Budget for Your Business
To get started on acquiring a small business inventory loan, you need to prepare a budget. This will help the lender review and consider the following information:
- Your company’s business credit history and credit rating
- Your personal credit history and ratings
- The amount of time you will need financing
- Your ability to pay back the funding
Included with your budget, you need to highlight your usual inventory turnover ratio, facts about your inventory management system, and your company’s annual revenue. Add financial statements, such as cash flow statements and profit-and-loss statements, for lender review.
By creating a budget and inventory record, your goal is to show the lender you can repay the financing you receive. Show them your need to buy the inventory, expand your business, or support your operations sufficiently during peak times.
Calculate how much you will need to borrow
To figure how much you will need to borrow, you need to know the borrowing base, or how much your company can borrow. Therefore, you need to know how much inventory you wish to purchase to satisfy customer demand. Determine your borrowing base by multiplying your collateral, or the amount of the inventory you wish to buy, by the percent of the amount the lender can lend.
You want to calculate your return on investment (ROI) from buying the inventory as well. For example, what will you pay for the loan each month after you factor in the fees and interest? Will you be able to manage the cost once you sell the inventory?
Compare loan providers
Each inventory provider has different terms to offer. Therefore, you need to scrutinize your choices carefully. For example, some lenders will lend you 70% of a liquidated inventory’s value, while other lenders will give you the full value. However, you also have to consider other things, such as the interest rate. Additionally, consider whether the lender requires an appraisal of the inventory (most of them do), the fees for the funding, and the payoff terms.
Is an Inventory Loan Right for My Business?
Inventory loans suit some businesses more than others. For example, good candidates for inventory loans usually possess the following:
- The business only has one funding need–to secure inventory
- A business credit score that makes it difficult to qualify for traditional financing
- The owner does not want to provide his or her business assets or personal assets for funding collateral.
- Strong sales record, which makes inventory loan payback easier
- The company does not mind agreeing to the lender tracking inventory turnaround as a stipulation for getting a loan
If you can agree to all or most of these conditions, you may be eligible to apply for an inventory loan. Although it may be difficult, it’s worth taking the time to decide if this decision is right for you and your business.