Small Business

A guide to small business inventory financing

Keeping your shelves or warehouse stocked with inventory is crucial if you run a wholesale or retail business. By failing to meet demand, you’re running the risk of losing customers (and in turn, sales) — a situation that no business owner wants to find themselves in.

Inventory financing can help when you don’t have the cash flows to purchase the inventory you need to meet customer demand. An inventory loan can also come in handy if you come across a great deal on products that’s just too good to resist.

Understanding the fundamentals of inventory financing and how it works can help you decide if it’s the right funding option for your business.

What is inventory financing and how does it work?

Inventory financing is short term, asset-based financing that’s used exclusively to buy the inventory or products your business sells.

This type of financing is secured by the inventory or products that you’re purchasing. That means you don’t have to offer the lender any personal collateral. But if you default on the loan, the lender can repossess the inventory you purchased as payment.

Inventory financing can either function like a term loan, which means it has a set payoff date and fixed monthly payments. Or, it can be a revolving line of credit that you can draw against as needed. Although some lenders may finance 100% of the inventory value, most typically offer a set percentage of the inventory’s value, which may be anywhere from 50% to 80%. Depending on where you borrow, actual dollar amounts for loans may range from $25,000 to $500,000.

Loan terms usually max out at one year, although it’s possible to get a longer repayment term with certain lenders. Origination fees vary, but all lenders will charge interest on the money you borrow.

Is inventory funding right for me?

Inventory financing is appropriate for product-based businesses but if your business is service-based, other types of small business financing are better suited for your industry.

Businesses that benefit from inventory financing include: clothing stores, bookstores, e-commerce sellers wholesalers, and seasonal businesses that need to stock up on inventory before the holiday rush begins.

An important thing to consider is whether your business could qualify for inventory financing. Generally, the minimum requirements for an inventory loan or line of credit include:

  • At least one year in business
  • Consistent revenues
  • Demonstrated financial ability to repay the loan

Some lenders may also impose a minimum requirement for borrowing. You may have to get a minimum amount of financing, say $100,000, as a condition of getting funding. This is an insurance policy for the lender, assuring them that the inventory you’re purchasing has a substantial enough resale value in the event that you default on the loan. The lender may also ask for a detailed report outlining your typical inventory turnover rate.

You’ll notice that credit scores aren’t on the list, which is somewhat atypical for a small business loan. While lenders can, and do, check credit scores for inventory financing, it’s not as important as your time in business, annual revenues, and how much you need to borrow. Lenders gauge your ability to repay inventory financing by your overall financials first and your credit score second.

Pros:

There are some definite advantages associated with inventory financing.

  • You can get a loan without having to offer personal collateral.
  • It can help you stockpile inventory ahead of the busy season.
  • Loan funding is typically quick once you’re approved.
  • Poor personal credit isn’t always a barrier to approval.
  • It allows you to keep pace with customer demand, and not lose out on sales.

Cons:

At the same time, there are some characteristics of inventory financing that could make another loan option more attractive.

  • Getting approved can be difficult if you don’t have the operating history or revenues lenders are looking for.
  • Inventory loans may carry higher interest rates compared to other types of longer-term small business financing.
  • While loan funding may be fast, loan approval and underwriting can take several weeks to complete.

Small business inventory loans: what are my options?

If you’re looking for an inventory loan or line of credit that uses the inventory you’re purchasing as collateral, you can find them at banks as well as online lenders.

A traditional bank may be able to offer you a more favorable interest rate if you have an established banking relationship. Online lenders can make it easier to apply for inventory financing by allowing you to submit your application and upload supporting documents online. And depending on the lender, you may be able to get the loan funded in just a few business days once your application is approved.

The approval can be the hard part for either type of lender. If you don’t have any luck getting approved for inventory financing through an online lender or a bank, there may be other financing options you can try.

Alternatives to inventory financing

Term loans

A term loan allows you to borrow a lump sum, either at a fixed or variable interest rate. Term loans are repaid according to a set schedule. A short term loan may be repaid in less than a year; long term loans may give you up to five years to repay.

You can use a term loan to buy inventory for your business and it’s possible to do so without collateral. But you’ll likely have to offer a personal guarantee, which means the lender holds you personally responsible for repaying the debt.

Merchant cash advance

A merchant cash advance is another type of short term financing. Instead of using your inventory as collateral, you borrow against your future credit card receipts.

The main advantage of a merchant cash advance is that can be easier to qualify for if you don’t have perfect credit or you have a newer business. The downside is that merchant cash advances can carry much higher rates than other types of business financing, potentially making them an expensive way to buy inventory.

Invoice financing/factoring

Invoice financing and factoring are similar to a merchant cash advance. The difference is that you’re borrowing against the value of your business’s outstanding invoices.

This type of financing is flexible, in that you can use it to purchase inventory or meet any other business funding need. But like a merchant advance, you could end up paying much more in interest for this type of loan.

Business line of credit

You can use a business line of credit to purchase inventory on an as-needed basis. Both banks and online lenders offer business lines of credit.

Interest rates may be more favorable for this loan option, compared to a merchant cash advance or invoice financing. But, it can be more difficult to qualify for a business line of credit if you have a newer business or lower credit scores.

How to prepare for an inventory loan

If you’re planning to apply for inventory financing, it pays to spend some time getting your application in order. The stronger your application, the better your chances of being approved.

First, take a look at your business’s financials. Update key financial documents, including your profit and loss statement, cash flow statement and balance sheet. Pull copies of your business and personal tax returns for the previous two years, along with at least three months’ worth of bank statements for your business accounts. Together, these documents can give you an idea of how a lender will view your business’s financial standing.

Next, assess your inventory financing needs. Create an inventory list through your inventory management system that shows what you already have on hand. Run an updated report for your inventory turnover rate. It may also be helpful to make some sales projections so the lender has an idea of how much revenue the inventory you’re purchasing is likely to generate.

Finally, review the lender’s application guidelines carefully to make sure there’s nothing else you need to apply. And once you submit the application, be prepared for the lender to request additional financial details about your business or inventory financing needs before final approval.

Business inventory loans: things to consider

One last thing you can’t skip with inventory financing is determining how much you can realistically afford to borrow. Using a business loan to purchase inventory could do more harm than good for your business if you’re not able to repay it on schedule.

Here are two things to focus on as you consider business inventory loan options:

Length of term

First, consider how long you’ll have to repay an inventory loan. Ideally, you should be able to sell your inventory relatively quickly so that you can repay the loan on schedule.

This is where sales forecasts become important. If you have an accurate idea of how soon you’ll be able to sell the inventory you purchase, that can help you choose an appropriate loan term.

APR

Next, look at the annual percentage rate a lender charges. While it’s possible to get loans for inventory funding at low rates, some financing options may have an effective APR that’s well into the double-digits.

The higher rate and the longer the term, the more financing costs, which can eat into your bottom line.

Finance inventory with Funding Circle

As a small business owner, when you need inventory, you need it right now. You don’t have time to waste jumping through hoops to apply for financing and then waiting around to find out if you qualify.

Funding Circle offers term loans from $25,000 to $500,000, with repayment terms ranging from 6 months to 5 years and rates starting at just 4.99%. You can apply for a loan online in just 10 minutes, and get a decision in as little as 24 hours after document submission.

If you want a quick and simple way to get inventory financing for your business, take a few minutes to check your personalized rate for a Funding Circle loan!

FAQs

Why should I get financing from Funding Circle as opposed to a bank or other lender?

The underwriting process at traditional banks can be lengthy, confusing, and opaque. We’ve taken the best parts of a Small Business Administration (SBA) term loan — like fixed and affordable monthly payments and no prepayment penalties — and created something faster and more flexible. Unlike traditional finance companies, we also deliver a best-in-class and transparent experience to our business customers. You’ll work with a dedicated loan specialist who will guide you through the entire application process and remain focused on meeting your unique financing needs. We strive to deliver a decision quickly — often as fast as 24 hours after you submit your application.

How long does it take to apply for working capital through Funding Circle?

Funding Circle’s application process is quick, easy, and transparent. You can apply for a loan and get your free instant quote in just 10 minutes, and have the money in your bank account in as few as 5 days.

Are your loans secured? What collateral do your loans require?

Yes, all of our loans are secured. We require a lien on your business assets and a personal guaranty from the primary business owners. Collateral can include, but is not limited to, equipment, vehicles, accounts receivable, and inventory.

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