How to Leverage Inventory Financing Options

Inventory financing is an incredible financial tool for your business that allows you to leverage your inventory and increase operating cash. But how exactly is this done?

Jason Styles

Why Inventory Financing?

If you lead a business selling physical goods and you believe in the products you’re making, odds are you’ll end up stocking a surplus of your best products. It’s preferable to store extra goods than have an empty shelf or “out of stock” displayed.

With dozens of priorities on any given day, modern business leaders should have more that they have to worry about than inventory management. But inventory management is one of the most essential things a business can do to succeed.

When businesses end up spending valuable cash on large inventory stock, they face a timing gap between dollars going out the door and corresponding revenue coming back in. 

The timing gap between the purchase of inventory and customer cash inflow is a core driver of what is referred to as the “working capital gap.” This gap leaves operators temporarily strapped for cash, as they wait for their inventory turnover to complete and convert to cash.

Inventory is one of many cash requirements a business has, so what can be done when cash is tied up in inventory? 

What Is Inventory Financing?

Inventory financing is an inventive financial tool that leverages your inventory to cover other short-term cash needs in advance of receiving cash from customers. 

Inventory financing allows business leaders to leverage inventory to gain incremental operating cash. This funding solution, like most others, comes at a cost – it will always have an interest rate and often comes with other fees that businesses should be wary of. 

Additionally, most lenders will use the inventory, and oftentimes other assets, as collateral. Collateral is what the lender has a claim to collect in the instance that the business is unable to repay or also known as a default.

Traditional loans and lines of credit place emphasis on credit history and other indicators of business creditworthiness. For small or early-stage businesses, these data points potentially don’t exist yet (or don’t tell the whole story). This boxes many businesses out of access to financing which is evident by the cash gap in the capital markets. Alternative financing, more specifically inventory financing, is a specific and innovative form of funding that helps to fill this gap.

The big players in the inventory financing space get comfortable with granting credit without seeing extensive credit history because they use inventory and occasionally other assets as collateral.

For restaurants, retailers, wholesalers, car dealerships, seasonal businesses and so many more, inventory requirements will be hefty. This doesn’t have to be a cash drain, but rather a perfect use case for inventory financing. Instead of having cash locked up in inventory, operators can leverage it into additional operating cash, without having to sacrifice any inventory. 

This liquid cash can be used to:

  • Pay business expenses
  • Prepare for peak season
  • Take advantage of time-sensitive deals and promotions
  • Reinvest into the business
  • Develop and roll out new products
  • Purchase additional stock

How Inventory Financing Works

Inventory financing will always secure the loan or line of credit against inventory. A loan provides the “full” amount upfront and can only be used once, while a line of credit can be used on an ongoing, as-needed basis, with multiple draws up to the limit. 

These loans or lines of credit won’t be 100% of inventory sale value, but they should make a substantial difference to a company’s liquidity. Lenders use many creative methodologies in determining financing value, but typical proposals range from 50% to 80% of the inventory’s appraised liquidation value. 

The liquidation value is less than the market value because the appraiser considers the friction of trying to receive comparable prices in an asset liquidation process. All parties are aware of the process dynamics and the seller has typically relinquished all competitive power to the buyers.

Lenders use a liquidation appraisal value because if a business cannot repay their inventory financing, the lender can put them in default, repossess their collateral, and sell it to cover the outstanding balance. It’s worth noting that in most cases where this occurs, it will be because the borrower was having trouble selling through its inventory in the first place; so, it’s not typically a situation that any lender wants to be in. Lenders are not in the business of selling protein bars, nor do they want to be.

Lenders will also charge businesses a fee or in many instances multiple fees for inventory financing. Fee packages differ amongst lenders, but all will charge at least an interest rate on the outstanding balance.

For example, peak season is coming up for many businesses, and it is time to stock up on inventory. After applying for inventory financing through an online lender, you submit the inventory report which shows appraisal value to be $350,000.

The lender offers you a loan or a business line of credit for 70% of the appraised value, or $245,000, in exchange for your agreement to pay them interest at a stated rate on however much you draw. When an operator chooses the loan, they are immediately provided with the $245,000 and are charged interest on the outstanding balance at the stipulated rate until repaid. When the operator chooses the line of credit, they have the option to draw up to $245,000 in one or multiple requests, over a certain period; additionally, they will incur interest on the outstanding balance at a stipulated rate.

Pros and Cons of Inventory Financing

It is essential to understand the core considerations – both pros and cons - of inventory financing. 

Pros of Inventory Financing

  • For executives of seasonal businesses, inventory loans and lines of credit can provide funding for the busy seasons without using up all the (relatively lower) cash balance during the off-season 
  • A fluid line of credit provides executives with an ongoing source of extra cash; this can be a useful cash management tool as unforeseen expenses arise, or simply for dealing with recurring expenses over time.
  • Traditional lenders often require a personal guarantee (“PG”) for loan approval. This is where the lender uses personal assets such as the CEO’s home, vehicle, or personal finances as collateral. With inventory financing, personal assets are never used as collateral.
  • Lenders don’t rely as much on credit ratings/history, making it much easier for early-stage companies to qualify.

Cons of Inventory Financing

  • There are frequently many hidden fees, and overall fees will be higher for newer or stalling businesses.
  • Repayment may be problematic for smaller businesses; terms are set upon engagement and can result in default and seizure of collateral if not met.
  • Restrictions for the usage of inventory financing proceeds. For example, the agreement may restrict repurchase of stock, operating expenses such as payroll, or purchase of new equipment.

How to Get Inventory Financing

Once an executive deems inventory financing an adequate option, they should shift focus to examining their options. Typical options include banks, online lenders, and other alternative financing companies. 

It is crucial to understand the differences between lending packages; some considerations include the fee rates and which fees exist, if all can be drawn at once, potential restrictions on usage of proceeds, and repayment terms. These differ across lenders and should be the core decision-making criteria.  

Executives should approach an inventory financing application process armed with business information listed below:

  • Balance sheets
  • Income statements
  • Cash flow statements
  • A projection model/business plan
  • Inventory management system records
  • Accounts Payable Aging Schedule - showing you pay your vendors timely
  • Account Receivable Aging Schedule - showing your customers pay you timely
  • Inventory report

After applying, the lender will begin the review process. This process includes due diligence to review your financials, understand your projections model/business plan, and perform a deep dive into your inventory reports/management systems.

Assuming everything checks out, the lender will approve you for inventory financing; and once the paperwork is executed, you can begin the process of requesting funds.

The Bottom Line

Inventory financing is a great way to turn inventory into additional cash that enables operators to purchase additional inventory, pay bills for business expenses, pump money into the sales and marketing funnel, or offer new products. It is especially helpful for supporting growth in situations where the business may not be eligible for a traditional line of credit or loan.

Remember that the application process for inventory financing varies from lender to lender, as do the terms of the financing itself – it is important to do your research and find out which lender works best for you. 

Time to Boost Your Sales

At Ampla, we truly believe that founders, not lenders, should have control. Consequently, Ampla provides a non-dilutive, flexible line of credit, which can be used for a wide range of business expenses. 

The line size is determined by retail and eCommerce channel projections, to provide as much capital as possible. As your business grows, the line will show its flexibility and grow in stride.

There is no early repayment penalty as Ampla offers flexible repayment, getting repaid as the business generates sales. If sales slow, so do repayments. There is no maturity or fixed repayment date.

Lastly, Ampla only charges one interest rate – you will never pay more than your stated annual percentage rate (“APR”). 

Don’t let your cash remain tied up in inventory. Schedule a call today to see how a partnership with Ampla can solve cashflow problems and ignite growth.

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Published on
November 29, 2021