As a small business owner, you may find yourself with more sales than the inventory you need to fill orders. Or, cash flow may have you in a pinch that limits your ability to buy the supplies you need to grow your business. Seasonal businesses may require an influx of cash to make the business viable before the busy season kicks in. For these reasons, you might want to explore your options for inventory financing.
What is Inventory Financing and How Does It Work?
Inventory financing is a type of funding where you borrow money to buy the products your small business sells. Here’s how it works. Say you own a candy store and need candy, beverages and other treats to sell. You might apply for inventory financing to cover the costs of those wholesale products that you turn around and sell at retail, using the money you earn from those sales to repay the lender. The amount of inventory financing you will qualify for depends on the value of the inventory you want to buy. Many lenders will only offer a percentage of the full value ranging from as little as 20% to as much as 80% or more. This is how lenders compensate for the anticipated depreciation of the inventory and the risk that you may default on the loan. In most cases, the products you purchase are the collateral on the financing, which means your lender won’t require you to offer personal assets or other business assets to secure the short-term loan.
Is Inventory Financing Right for Your Business?
Inventory financing allows you to buy the inventory you need to run your business. Simply put, inventory financing can be the difference between successfully running your business or not. If you have the financing to buy the inventory, you can fill your orders and grow your business. You might rely on this type of financing to:
- Respond to high customer demand
- Update your product lines
- Steady your cash flow during peak and slow seasons
- Increase inventory supply
Inventory financing may not be suitable for your business if you won’t have the sales necessary to pay back the lender. Don’t rush into inventory financing because it could mean your creditworthiness could suffer if you can’t make payments.
Pros and Cons of Inventory Financing
As with most types of small business financing, inventory financing has pros and cons. You can usually decide if inventory financing is right for you by reviewing the pros and cons.
Pros of Inventory Financing
For starters, using inventory financing allows you to sell more products since, without the funding, you may not have the resources you need to meet customer demand. Inventory financing makes sales possible, especially if you have a seasonal business or a sales cycle that fluctuates—the other pros of inventory financing deal mostly with accessibility to the money. Depending on your lender, you can get inventory financing faster and easier than some other types of business funding. Since the inventory will secure the loan, lenders can accept your application more readily, even if you have a bad credit score or have long been in business. Traditional banks and credit unions may still require that you have a good credit score and be well-established as a business owner. With online lenders, you may be able to be approved and receive funding in just a few business days.
Cons of Inventory Financing
The main downside of inventory financing is that this type of funding can be more expensive over the long term due to the fees and interest payments you will be required to make. Another con of inventory financing is that lenders may not loan you the full amount of money you need but rather a percentage of the total cost of the inventory you’re planning to buy. As a result, if you are a new business owner with other debts related to starting your small business, you may find it difficult to repay a short-term loan for inventory. Also, your lender may need to inspect your facility and the financed inventory to ensure it holds its value until the inventory is sold. This may force you to pay an appraisal fee, which could delay the financing altogether. Furthermore, some lenders may require that you present collateral in addition to the inventory you are financing.
What are Your Options for Inventory Financing?
If you are wondering how you get funding for inventory, there are several ways to go about it. It’s wise to consider your options for inventory financing to determine which is right for your small business. Read on to learn what types of inventory financing there are.
Inventory Loan
An inventory loan is more of a combination of inventory financing and a small business loan. With an inventory financing loan, you borrow money based on the value of your inventory. The loan is a set amount versus a revolving amount. You make regular monthly payments on an inventory loan during a term agreed upon with the lender. You might also pay back the short-term loan in a lump sum once your inventory has been sold. Once you pay back the full amount of an inventory financing loan, you would need to apply for another loan if you need more financing. That differs from a business line of credit, where you can borrow and pay back and borrow again.
SBA Loans
SBA loans are guaranteed by the U.S. Small Business Administration. The loan does not come from the government but rather from banks, credit unions and online lenders that are approved to offer SBA loans. Interest rates and terms for SBA loans are favorable, but it’s not easy to qualify for this type of funding. You will be expected to demonstrate strong sales history and at least two years in business, depending on the type of SBA loan you want. Of course, the terms of your SBA loan will vary by lender. To qualify for an SBA loan, you may need good credit with a credit score of at least 680 on a scale of 300 to 850. You may also be expected to offer personal assets as collateral that the lender will claim if you do not repay an SBA loan.
Line Of Credit
A business line of credit works like a credit card. You apply for a short-term credit line and then use the funds as needed and pay them back. You can use this credit line for business expenses like payroll, inventory, rent, and more. A line of credit may be more affordable for your company because you pay interest only on the amount you use versus being charged interest on the entire amount of a more traditional business loan. You can get a business line of credit from a wide range of lenders, including banks, credit unions and online lenders. Each lender will have different requirements that you must satisfy in order to qualify for a line of credit.
Small Business Term Loan
Small business term loans are usually geared toward small businesses that need more money than typical inventory financing can provide. For example, if you need to borrow up to $350,000 for two or three years, a small business term loan may be right for you. To qualify, you will want to be in business for at least a few years and be able to show that your small company is profitable. Find a lender that doesn’t charge a lot of fees or prepayment penalties if you pay off the loan before the term is up. Banks and other traditional banking institutions may make it difficult to qualify for a small business term loan. But online lending partners are known for responsive service and funding in just a few business days.
How To Apply for Inventory Financing
Applying for inventory financing will depend on the type of lender you select and the amount of inventory you hope to finance. You will need to provide your company details during the application process, and your credit score will be reviewed in most cases. Online lenders have simple applications you can complete and expect to get approved quickly. However, traditional banks and credit unions offering inventory financing may be slower about providing the funding. In fact, some traditional banks and other financial institutions don’t offer inventory financing because they don’t want to risk needing to siege and store the inventory if the business owner doesn’t make payments. If you have decided that inventory financing is the right approach for your small business, find a lender you trust and follow their application process.
