Running a small business comes with several challenges, especially when it comes to maintaining a consistent cash flow and inventory. To continue running smoothly, many business owners seek financing options, such as small business loans, to fill the cash-flow gap.
If you have large amounts of inventory to maintain, inventory financing might be a viable option to meet your business financing needs. Read on to learn more about inventory loans, the types, pros and cons. You’ll also learn the costs associated with this type of financing, whether it’s right for your business, and where to get one.
What is Inventory Financing?
Inventory financing, sometimes referred to as inventory loan, is a type of short-term loan that gives you access to funds to purchase products to sell. Typically, the products you’re looking to buy, serve as collateral, so you don’t need to provide any other form of asset to back up the loan. However, if you default on your monthly payments, the lender will seize the inventory you haven’t sold to recoup the outstanding loan balance.
Due to the flexibility and the cash availability inventory financing offers, it’s the best option for businesses with seasonal sales slumps or a huge junk of physical assets. In addition, since lenders have more interest in the value of the inventory you want to buy when evaluating loan applications, it’s often easy to qualify for an inventory loan compared to other small business loans.
Is Inventory Financing Right for Your Business?
Inventory loans are specifically designed for small businesses in retail because they often have large quantities of assets. These businesses can seek this type of loan to get the additional stock to prepare for peak seasons as they know they’ll pay off the loan quickly once they sell the products.
Retailers, wholesalers, and seasonal businesses experiencing an influx of demand for their products in specific seasons of the year might benefit from inventory loans. In addition, inventory financing is a great funding solution for your business if you have larger amounts of inventory or seasonal sales slumps.
Types of Inventory Financing
There are two common types of inventory financing: inventory loans and inventory lines of credit. While both have unique structures, you can secure any using the inventory you plan to purchase.
Inventory Loan
Also known as term loans, this type of financing is based on the total value of the inventory. Inventory financing works much like traditional term loans, where you get a specific amount of capital and repay it with interest over a given period of time. However, term loans typically have higher borrowing limits and longer repayment periods, making them the best option for financing large inventory purchases.
Inventory Line of Credit
An inventory line of credit works similar to a revolving credit as you can access a set amount of money on a needed basis, and you only pay back what you’ve drawn. Once you’ve paid off the amount, you can borrow again up to the maximum approved limit.
Advantages of Inventory Financing
There are several reasons many businesses turn to inventory financing whenever they’re in a tight financial spot. Here are some of the benefits:
- No Need for Collateral: Several business loans require you to pledge your personal assets to act as collateral if you default on loan payments. However, with inventory financing, there’s no risk of losing your car, home, or any other assets under your name. The inventory you purchase becomes collateral, and even in the worst-case scenario, you’ll only lose the inventory bought using the loan.
- No Personal Credit Score Required: Lenders don’t care that much about your personal credit scores when applying for inventory financing. What they look at is the inventory’s value. For this reason, it’s possible to get this form of funding without a credit check.
- Easy Application Process: Getting an inventory financing loan is way faster than traditional loans. Less paperwork is needed, and it usually takes a couple of days or weeks to get approved and funded.
- Offers Convenience: No business wants to lose potential clients because they’re out of stock. Access to an inventory loan or a revolving line of credit allows you to stock up your shelves and meet your customer demand during peak seasons.
Disadvantages of Inventory Financing
Like any other form of small business financing, inventory financing has downsides too. So it’s wise to weigh the pros and cons to decide whether it’s right for you.
- Expensive: Inventory financing typically comes with higher interest rates compared to traditional bank loans. Lenders charge high rates to protect themselves from the risk as there’s no personal collateral that can be seized apart from the inventory in the event that you default.
- Limited Loan Amounts: While lenders approve and fund inventory financing within the shortest time, they typically offer a certain percentage of the total cost of the inventory you want to buy. This can lead to delays and shortfalls if this is the only loan option you have to keep your business operations running.
- Risk of Drowning in Debt: New small businesses may already be in debt as they try to establish themselves. Taking out inventory financing can add more liabilities to the company, thus increasing the risk of sinking into debt.
Associated Costs with Inventory Financing
As with any other small business financing, the interest rates, terms, and fees of inventory financing vary depending on the lender and the current financial situation of your business. Therefore, before you submit your loan application, read the fine print of the terms and fees involved.
Here are some of the common fees involved with an inventory loan or a business line of credit.
Origination Fees
This is the fee charged by the lender in order to process a new loan application. Loan origination fees are usually a percentage of the total loan amount.
Appraisal Fees
This is the amount you pay to send an appraiser to determine the value of your inventory. Remember, lenders use a business’ inventory value to determine how much loan they can give you.
Interests
Like any other loan, you’ll pay back the borrowed amount plus interest. The rates can vary dramatically depending on whether you use banks, credit unions, online lenders, or an inventory financing company to secure the loan.
Prepayment Fees
You’ll incur a prepayment penalty when you pay off your loan ahead of schedule set in the loan agreement.
Late Payment Fees
The lender charges a late fee when you fail to make your loan payments by the due date. Late payment fees are often outlined in the agreement, so be sure to check beforehand.
