An organization’s inventory — which includes its raw materials, work-in-progress goods, and finished goods — forms the backbone of its supply chain. Any problem in even one of these components creates unnecessary delays and increased costs. For example, if there is not enough material in stock, that affects the production volume of an organization. Likewise, if a company’s inventory conversion period is extended, it will take exponentially longer to break even or become profitable in the market. Show
Inventory financing is key to resisting such problems, especially for Small and Medium-Sized Businesses (SMBs). What is Inventory Financing?This is a short-term financing option for SMBs, who use the money to purchase stock and materials that they will employ to produce and sell products later. As a result, this type of financing can help organizations replenish and consolidate their inventory levels. Normally, inventory financing consists of short-term loans and revolving credit lines that enable businesses to make emergency withdrawals and fund usage. In this way, inventory financing is an ideal fund-creating avenue for stabilizing cash flows, especially during periods wherein sales are volatile (for example, a seasonal sales downturn). Inventory financing is an asset-backed option in which the products and materials purchased with the funds are the borrowing collateral. The loan's value provided by the lender is based on some or all of a business's inventory or stock valuation. An example of of how inventory financing works is as follows: A vehicle dealership named Cadmium Motors needs to expand its inventory to keep up with a seasonal rise in new vehicle orders and new car sales. To meet the rising demand, the dealership needs to purchase new cars from a vehicle manufacturer named Kree Vehicles. This will cost Cadmium Motors more money than they have set aside for the purpose. Therefore, Cadmium Motors approaches a financing company to bolster its inventory funds. The financing company sends auditors to closely evaluate the value of the cars being purchased. After the check, the financing company approves the loan if its creditworthiness and inventory value criteria are met. When vehicles are sold, Cadmium Motors can use the money earned in the transaction to repay a part of the loan and purchase more inventory to sell. The financing company has offered inventory financing as a revolving credit line. So, if Cadmium Motors is selling well and is in need of more money to keep selling, they can withdraw money and repay it later to the financing company Which Financiers Provide Inventory Financing Solutions?Certain financial bodies may specialize in providing inventory funding solutions to businesses, especially SMBs. Some of these financiers are:
Compared to banks and other financial institutions, online lenders also tend to simplify the application and fund release procedure. Drip Capital is one such online inventory financing company based out of Palo Alto, California. With novel trade finance products for inventory management, we've helped more than 50+ importers in the United States to improve their working capital position and profitability with on-demand financing.
Small business loans generally tend to involve collateral, longer terms, and lower interest rates. The latter two aspects of these loans may skew businesses to opt for this alternative. On the other hand, the lenders of small business loans require businesses to have a strong credit score, several years of industry establishment, and steadily growing annual revenue and profitability. So, not all inventory finance seekers will be able to secure funds through this avenue. What Are the Features of Inventory Financing?A typical inventory financing arrangement has the following characteristics:-
The features above do not necessarily span all the inventory financing types and How Does Inventory Financing Help Businesses?Inventory financing is highly beneficial for businesses that have a dominant percentage of their capital tied up to their business inventory. Therefore, manufacturers and dealers of goods use this financing option most frequently. Inventory financing helps businesses in a multitude of ways, some of which include:-
What Are the Disadvantages of Inventory Financing?SMBs need to weigh all their options before deciding to go for inventory financing, as this option contains its fair share of negatives, some of which include:
What Are the Types of Inventory Financing?Inventory financing options are not limited to just standard term loans, but can be offered in many different forms. We've the various types of inventory financing separately in this post. Some of the most common ones are:- More often than not, these credit lines are revolving in nature. Credit lines enable SMBs to purchase materials and other inventory on credit. After repaying it, businesses can dip into the replenished credit available again for withdrawal. Additionally, SMBs, more often than not, do not have to pay interest on the part of the credit they do not use. Inventory LoanThese are short-term loans with quick turnover time to quench an SMB's inventory financing requirements within a quick time-frame, for a lower financing amount and short repayment periods (normally, in the six to seven-month range). This improves the inventory conversion of such businesses. Vendor FinancingAfter agreement on certain payment terms, vendors let buyers purchase inventory from them and lend them the money to buy from them. This money is payable to the vendors at a later date, usually after 30 to 90 days. This is a simple and yet one of the most effective financing options. Also synonymously referred to as a vendor credit or vendor loan. We've covered this topic separately here. Financing for Inventory PurchaseThese are cases where funds are extended precisely for purchasing inventory and the inventory itself is also the collateral in the transaction. It is also the most popular definition of the term. Inventory backed financingIn several cases, financiers may also extend the loans based on the current inventory that a reseller already has stocked. The loan itself may be used for multiple purposes including funding operations and need not be restricted to purchasing inventory. Business owners can purchase inventory through a different funding method known as purchase order financing. How Does Inventory Financing Work?As specified earlier, inventory financing can play out in the form of term loans or credit lines. In term loans, the financier provides the full amount upfront. A business can repay this amount over fixed monthly payments over an agreed period. On the other hand, while using a credit line, businesses only have to repay the interest amount for the credit used. Once the interest payments are done, the withdrawable credit limit reverts to the original sanction. The working mechanism of inventory financing can be explained with an example: if business A Ltd. wishes to purchase $ 500,000 worth of inventory to ready itself for its next production cycle, it will contact a financier. The financier will then conduct a thorough evaluation of the inventory to ascertain its current market value. The lender's auditing team finds that the valuation is $ 350,000. The lender provides 80% of that value, which is $ 280,000. The monthly interest rate for the same is 17%. If, over the course of its production cycle, A Ltd uses the full amount provided, it will need to pay back (over 12 monthly installments over a year) an net amount of $ 327,600 (borrowed amount + accrued interest). Every month, that translates into USD27,300 repayments made by A Ltd to the financier. In case the financing is done through the credit line route, the business can repay the amount it withdraws out of the USD280,000 credit limit (with interest). Once the repayment is made, the credit limit replenishes into USD280,000 again. In both instances, the inventory purchased using the borrowings is seized as collateral if A Ltd is unable to repay the used amount and interest. Documents such as a filled application form, passport-sized photographs, bank statements, the bank statement, balance sheet, and profit and loss statement of the past one year (both must be audited) along with income tax returns statement, sales tax returns statement, A Ltd's registration certificate, documents specifying information about the collateral, and income and address-proof documents for A Ltd. In the records of a loan-seeking company, a financier generally evaluates certain factors, including:-
What kind of Businesses Need Inventory Financing?As stated earlier, businesses with a high percentage of their capital tied in their inventory are more likely to seek inventory financing than most other businesses. So, businesses in the manufacturing, construction, retail, and similar industries may seek inventory financing more than the ones in other sectors. What Are the Steps to Apply for Inventory Financing?The application process to secure an inventory financing solution firstly necessitates the following — the submission of documents that indicate the following: that the company is operational and located in its place of establishment for several years, has a high-value in terms of inventory possession, has been operational for at least six months, has a strong credit score, and other aspects.
What Are the Inventory Financing Rates and Terms?As one can expect, globally, the inventory financing rates, interest rates, and terms/conditions will fluctuate wildly. Financing can occur from 70% and above of the inventory value of businesses (based on the financier's evaluation), provided that inventory prices are relatively non-volatile. The interest rates can vary from as low as 5-6% to about 15-20%, or sometimes even more, for inventory financing. What Are the Alternatives to Inventory Financing Loans?There are three options that can be just as alluring as inventory financing loans for businesses:-
What are the differences between Inventory Financing, Accounts Receivable Factoring, and Standard Working Capital Loans?Inventory financing may share a few similarities with factoring — short-term, working capital repairing, limited scope, to name a few — and working capital loans, but there are several differences between the three as well, including:- Inventory financing is a highly beneficial option for SMBs all across the world to raise money to manage their inventory efficiently. Its importance can only be felt in the case of a deficiency of money to stabilize a company’s inventory reserves. FAQs on Inventory Financing
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