Inventory Financing: What is It? How Does It Work?

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Inventory financing refers to a specific loan that is used to fund inventory purchases, with the purchased inventory being used as collateral to secure the loan. While there are companies that specifically do this, you can also use a regular term loan or line of credit to buy inventory.

How Does Inventory Financing Work?

When you apply for inventory financing, a lender or bank will extend you a loan or line of credit and use the inventory you are buying to collateralize the loan. Most commonly, inventory financing functions like a line of credit, but depending on the lender, it can be more like a term loan. Retailers, wholesalers, seasonal businesses and dealerships are the most common types of businesses that use inventory financing. Most businesses use inventory financing to cover short-term cash flow gaps, prepare for a busy season, launch a new product or generally grow their sales.

You will only get a portion of the inventory funded this way. Your bank or lender will only finance you up to a certain percentage of the inventory’s appraised value. In many cases, this is up to 50% to 80%. Your lender will use the liquidation value of your inventory, not the market value, as its appraised value, and this may be less than the market value. Some inventory may have little to no liquidation value, and if that’s the case, you’ll have little luck getting approved for financing. Lenders will generally use the Net Orderly Liquidation Value or the Forced Sale Liquidation Value to appraise your inventory.

Ex: Let’s say you have $1 million in inventory that you want to purchase. You approach your bank about getting financing for the goods. Your bank hires an independent agency to come up with an appraised value for the inventory. Perhaps they find its liquidation value is $800,000. Your bank then agrees to finance 50% of this value, so they give you a line of credit for $400,000. You can then draw from this line of credit to pay for your inventory purchases, and repay these draws over a series of months.

Inventory Financing Rates and Terms

In the table below, we cover the typical terms, features and rates associated with inventory financing.

Advance RateUp to 80% of inventory’s appraised value
Interest Rates0% - 35%
FeesIndependent inspection and appraisal fees
Loan TermsUp to 1 year

How to Get Inventory Financing

Many inventory financing companies have high minimum loan amounts, with some requiring borrowers finance at least $500,000. If this is more than you need, you should consider a standard term loan or line of credit instead. However, if you find that this is a fit for your business, you will need to prepare for the application process.

During the application process, a lender will look at your personal credit history and business finances, but there will also be a due diligence process. The due diligence process will investigate your inventory management system, the value of your inventory, the loss or damage rate, profit margins and inventory turnover. You may have to hire a third party to do an appraisal and review of your storage facilities, accounting and inventory management systems and the new inventory. Lenders can require you to redo this inspection process every three to six months, which can add to the cost of maintaining the credit line. We've heard of lenders even conducting surprise visits to inspect your warehouses and inventory.

Lenders want to finance inventory that has good resale value in the case that you default on the loan. If you can’t move your own inventory, a lender won’t want to use it as collateral for a loan. Inventory financing isn’t meant for new businesses or those without tangible products. Your business should be at least one to two years old when you apply. Lenders want to see businesses that have past success with buying and selling inventory and that keep impeccable inventory and accounting records.

Inventory Financing Companies

You may be able to finance inventory through a line of credit directly from your vendor, which has the added bonus of no interest and more flexibility on negotiating favorable terms. If that’s not an option, you can pursue financing from a lender or bank.

Financing OptionLoan AmountInterest RatesFunding Time
Vendor Line of Credit (“Net 30 Account”)100% of the inventory’s liquidation valueTypically noneSame day (part of the sales process)
BankUp to 60% of liquidation value3% - 6%Several weeks to months
Inventory Financing CompanyUp to 90% of liquidation value8% - 20%One to three weeks
Online LenderUp to $500,0008% - 80%One to three days

Pros and Cons of Inventory Financing

While inventory financing can make sense for many businesses, it isn’t always the right choice for funding.

Pros

  • Ability to leverage inventory to increase sales
  • Prepare for busy season by accumulating inventory
  • Credit line can grow with your business
  • May qualify for a bulk discount from vendor if purchasing a lot of inventory
  • Can be a good fit for businesses that have been rejected for traditional financing

Cons

  • Some companies have high loan minimums, usually $500k
  • May have higher interest rates than traditional financing
  • Long and expensive due diligence process
  • Ongoing inspections and appraisals (may be surprise visits)

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