Original article located at FitSmallBusiness
It takes cash to stock the shelves with the products your customers want. If cash is in short supply, you can get inventory financing to acquire inventory. In this guide, we will cover the basics of inventory financing, what you’ll need to get approved and how much you can borrow, and where to get an inventory loan or line of credit.
Where to Get Inventory Financing – Quick Comparison
Up to 100%
$300 to $500K
need to qualify
– Vendor must
– 1-2 years
can be pledged
as assets- Strong inventory
a bank account-Owner must have
a social security
4 to 6%
10 to 18%
18.25 to 33%
to get funding
Instant – part
of the vendor’s
What Is Inventory Financing?
Inventory financing is a short term loan or line of credit that is used by a business to purchase inventory. The loan or line of credit is typically secured by existing inventory, and sometimes, by an additional lien on other business assets.
The following types of businesses may benefit from inventory financing:
- Retailers – Many retailers use inventory financing because most of their cash is tied up in inventory. They can free up some of that cash by pledging the inventory as collateral and using the financing to acquire additional inventory. This ensures that the retailer has enough product on the shelves.
- Wholesalers – Wholesalers need a steady supply of inventory to fulfill incoming orders and replenish inventory that leaves the shelves.
- Seasonal businesses – If you’re a seasonal business, you can prepare for the busy season by using financing to acquire inventory during the off season.
There are a variety of ways to get inventory financing.
The Best Option – Ask Your Vendor
A good place to start is to ask your vendor if they will allow you to pay on credit. This is often the quickest and easiest way to purchase inventory when you’re short on cash.
Vendors may offer 30-90 day payment terms, collect a percentage of payment up front (deposit) and defer the rest to an agreed upon date, or collect installment payments over time. Although most vendors offer such services for free for their customers, some may charge an interest rate.
Before offering you a payment plan, the vendor will most likely check your credit history and business financials. However, a vendor is more likely than a lender to overlook issues such as a bad credit score or poor cash flow.
Other Financing Options
Traditional Bank Financing
You can go the route of traditional financing and get a bank loan or line of credit. This is the slowest option but an economical one. It’s just like getting bank financing for any business purpose, but since the funds are being used to purchase inventory, the bank will shorten the term of the loan or structure the financing as a revolving line of credit that you can draw on as needed to purchase inventory.
Banks prefer to lend to businesses with a strong cash flow and good credit. Value of inventory is a secondary consideration. If your business isn’t profitable, the bank is less likely to approve you or will approve you for smaller amounts of capital. The rates on bank financing are currently around 4-6 %, but they vary with the market.
Your existing inventory will serve as collateral for bank financing, but the bank may also place a blanket lien on your business assets, which allows them to go after any business asset if you can’t pay back the loan. You should be careful before agreeing to a loan with a blanket lien because it can affect your ability to get other financing.
Asset Based Lenders
Whereas banks lend based on cash flow and credit score, asset-based lenders look at two sets of assets–accounts receivables and inventory–in deciding whether to approve you for a loan. “We serve businesses that can’t qualify for bank financing because their profits or credit score aren’t high enough,” says Marc Smith, Senior Vice President at Magnolia Financial, an asset-based lender that provides inventory financing for B2B companies. The loan is secured by inventory and receivables.
Asset-based lenders take a much more hands-on role in assessing your inventory. Before approving you for a loan, they will inspect and appraise the inventory and assess your inventory management system. After that, they require monthly reports on inventory levels. Ideally, according to Marc Smith, they want clients with well-managed inventory systems who know exactly where their inventory levels stand at any given moment in time.
Asset-based loans have interest rates of approximately 10-18 %, and you can expect to receive funding in less than 1 month.
Online lenders Dealstruck and Behalf also offer inventory financing. These are fast and convenient but come at a higher cost. Online options are also good for businesses that don’t have a lot of inventory or receivables on hand and are therefore unable to qualify for an asset-based loan.
Dealstruck offers inventory line of credit of up to $500K. They are intended for small businesses with recurring inventory purchases and relatively fast turnover of inventory. Dealstruck pays your vendors directly for the inventory rather than sending money to the borrower, says Jason Fleming, Senior Lending Specialist for Dealstruck.
The biggest advantage of a Dealstruck line of credit is that you make interest-only payments for the first few weeks after taking out the loan. You have 24 weeks to pay back the draw with interest only payments for at least the first 4 weeks. The interest-only period can be extended if the business has slower turnover of inventory. This is useful to small businesses because they may not be able to afford larger monthly payments until the inventory sells.
Qualifying for a Dealstruck line of credit requires a 600+ credit score, $20,000+ in monthly revenues, and at least 1 year in business. If you’re approved, the interest rates range from about 18.25 % to 25.25 %, with the average being in the high teens. Every time you make a draw, there’s also a 1 % draw fee.
Online lender Behalf also offers a line of credit that can be used to purchase inventory. You can borrow up to $50,000 in under 4 minutes, says Rachel Siegman, content specialist for Behalf, and you have 6 months to pay it back.
Just like Dealstruck, Behalf pays the vendor directly instead of the borrower. If you purchase inventory through a vendor that’s already in Behalf’s database, Siegman says, the money will be transferred instantly and you will be able to get your inventory right away. If you want to purchase inventory through a vendor that’s not yet in the system, Behalf will onboard the vendor in a few days.
It’s easier to qualify for Behalf than Dealstruck. All you need to be considered is a social security number and US bank account. Behalf will work with new businesses, and they don’t have a minimum credit score requirement. About 40 % of businesses that apply for a Behalf line of credit get approved. They base approval on a multitude of factors, including social media and other publicly available data about your business. The annual interest rate on a Behalf loan is around 30 %.
Can You Qualify for Inventory Financing?
Type and value of inventory
Inventory loans and lines of credit are secured by your current stock of inventory. As a result, your eligibility for inventory financing depends in large part on the type of inventory you have. More specifically, lenders care about the liquidation value, which is the price that the inventory will sell for at auction if you can’t pay back the loan.
Some types of inventory have little or no liquidation value. For example, if you own a bookstore and are unable to sell the books, the lender won’t be able to either. The same goes for businesses that sell food, cosmetics, and other perishable goods. Unfortunately, you probably won’t be able to get inventory financing if your products don’t have a reasonable liquidation value. In that case, you’re better off getting anonline working capital loan or other type of business financing.
You also stand a better chance of approval if you have a good inventory management system in place. Asset-based lenders in particular take a hands on approach to assessing inventory management. If your inventory reporting and tracking systems are reliable and efficient, then you increase your chances of getting approved for a loan.
Other factors affecting approval
Type of inventory is a primary factor in approval. However, just like with any other type of business loan, these other factors come into play as well:
- Credit score – The higher your credit score, the easier it is to qualify for inventory financing. The exception to this rule is asset-based lenders, which care far less about credit score than they do about the value of your inventory and receivables.
- Time in business – A lender is always more comfortable lending money to a business with a history of sales than a brand new business. However, there are options for startups which we cover in more detail below.
- Business revenues – The stronger your business’ cash flow, the more likely it is that you will get approved because you show lenders that you can pay back the loan. Banks in particular are cash flow lenders.
How Much Can You Borrow?
The amount of money you can borrow depends primarily on the liquidation value of the inventory. Most lenders will give you somewhere between 30-60 % of the inventory’s liquidation value in financing. For example, if you have $1 million worth of inventory that would sell for $500K at auction, you would probably qualify for $150K-300K in inventory financing.
The exact amount will depend on the type of inventory you sell. A bank may advance 60 percent or even more for ready-to-sell big box items such as appliances or vehicles. On the other hand, a manufacturer of unfinished parts or components may only receive 30 % financing. The key factor is the liquidation potential and value of the inventory — how quickly and for how much money can the inventory be sold?
In addition to the value of your inventory, banks will look at your business’ cash flow. Without strong incoming revenues, don’t expect banks to give you a lot of financing. Two financial ratios that banks generally look at are Debt Service Coverage Ratio (DSCR) and Debt To Income Ratio (DTI).
DSCR is a comparison of your business’ net income to total debt payments–it measures whether your business’ income is sufficient to cover loan payments.
DSCR = Business Monthly Net Operating Income ➗ Total Monthly Debt Payments (Principal Plus Interest)
DTI is a similar comparison but takes into account personal debts and obligations, such as mortgage and child support payments.
DTI = (Total Monthly Personal Debt Payments ➗ Monthly Gross Income) * 100
Ideally, for the highest chances of qualifying for a loan, your DSCR should be at least 1.25, and your DTI should be no higher than 36.
Are you having trouble acquiring enough inventory to meet demand? You have numerous options to get inventory financing, from vendor financing to banks and asset-based lenders to online lines of credit. Use the funding to keep your shelves stocked, get through a seasonal slump, or replenish fast turning inventory.