1. What is inventory financing?
2. How can inventory financing help your business?
3. Types of Inventory financing
   1. Traditional financing
   2. Lines of credit
   3. Term loans
   4. Merchant cash advance
4. Accounts receivable vs. inventory financing
5. Pros and Cons of inventory financing
6. How to apply for inventory financing

If you're looking for ways to grow your business, you might've come across the idea of inventory financing before. Though this type of loan sounds simple, there are a lot of financial and practical details you need to be aware of. Check out our guide to learn how it works and see what type is right for your business.

 

What Is Inventory Financing?

This type of financing is a short-term, asset-based loan. The lender gives you funds for a set amount of time, and then you use the funds to purchase inventory for your business. The loan is backed by the products themselves, so if you default, the lender can confiscate the products. Ideally, you are able to sell all the products for a favorable sum though. Once this happens, you can repay the lender and have a profit left over that you can use to enhance your business.

A variety of industries use this form of financing to help them obtain inventory. It's common among retailers, restaurants, eCommerce vendors, and wholesalers. Typically, a business works with an inventory financing company if they are just a little short on funds but have high hopes of selling many products in the future. It's especially popular with startups, small businesses, and other companies that work with wholesalers that require payment upfront.

How Can Financing Inventory Help Your Business?

Why should you consider inventory-based financing? There are many perks to using this financing for your company.

• Get a loan without needing to have a good credit rating
• Back your loan with business assets instead of putting personal assets on the line
• Build a relationship with wholesalers that don't offer delayed payment plans
• Keep your business going through temporary lulls
• Maintain a steady cash flow during seasonal shifts
• Update your product lines with new, high-quality materials
• Accommodate unexpectedly high customer demand

Types of Inventory Financing

Inventory-based financing comes in a variety of shapes and sizes. Depending on your situation, you might end up using one or more of these options to help you get financing for your inventory needs.

Traditional Financing

This is the classic type of loan where your inventory becomes your collateral and you forfeit the inventory if you can't pay the loan. Usually, the provider collects this loan as either a monthly payment or a percentage of your sales. Here's a quick overview of what these loans usually look like.

• Typical uses: eCommerce sites and small retailers
• Average amount: Up to $2 million
• Usual interest rates: Fixed fee which may be up to 100% APR
• Typical minimum credit score: 600

Lines of Credit

A line of credit gives you funds for inventory, but it's more like a basic loan. Usually, you can only use the inventory as collateral if you already own it before you get the loan. Here are the details of this type of loan.

• Typical uses: Restaurants, wholesalers, and construction companies
• Average amount: Up to $250,000
• Usual interest rates: Around 4.8% to 80% APR
• Typical minimum credit score: 600

Term Loans

A term loan refers to a type of financing where you get a single lump sum. These loans have somewhat high origination fees and usually require companies to be in business for a while, so they don't work well for startups. However, they're an ideal option if you just need a little help instead of regular financing. Here are some things to know about term loans.

• Typical uses: Contractors and real estate companies
• Average amount: $5,000 to $500,000
• Usual interest rates: Around 11% to 30% APR
• Typical minimum credit score: 660

Merchant Cash Advances

These loans are essentially giving you an advance on the future sales you make. You get a percentage of your average sales, and then you repay it with a percentage of your daily sales. Merchant cash advances tend to have pricey rates, but they can be useful if other types of inventory-based financing aren't available to you.

• Typical uses: Startups
• Average amount: $500 to $750,000
• Usual interest rates: 70% to 200% APR
• Typical minimum credit score: 670

Accounts Receivable and Inventory Financing: What’s the Difference?

When discussing inventory-based financing, it's important to keep in mind that it is different from accounts receivable financing. Accounts receivable financing is another type of short-term loan that businesses can use to cover gaps in income. However, this loan is backed by your outstanding invoices. The lender gives you a loan that you pay once your customers pay the remainder of their balance to you.

Since they're backed by different types of collateral, the lending process is a little different. To qualify for an accounts receivable loan, you just need to have a lot of expected income from customers and back up your claims by showing the lender your invoices. Meanwhile, inventory-based financing is a little more complex. You have to provide a lot of details about your business plan and do your research on the inventory you want to purchase. Furthermore, the lender will factor in the fact that products depreciate in value before determining how much they can offer you.

Though inventory-based financing can take a little more time to apply for, it has some distinct benefits over accounts receivable financing. Unlike accounts receivable financing, you don't need to have a robust business with a lot of customers who have already agreed to pay you money. This is why inventory financing for startups is so popular. You can use it to get your business started even if you don't already have a lot of funds.

Pros and Cons of Inventory Financing

Should you get inventory-based financing a try? This type of financing can definitely be helpful, but it's not guaranteed to solve all your financial problems. To determine if it's a good strategy for your company, you'll need to consider the pros and cons.

Pros

The main pro is that you can get a loan without having a stellar credit rating or a lot of assets to back it. The products you buy with the financing are the collateral, so this type of loan isn't as risky for you. Even very new businesses can be eligible for inventory-based financing.

Another benefit is that it allows you to easily adjust your inventory as needed. Coming off of a sales slump but suddenly have a bunch of interested customers? Inventory financing lenders give you access to ready cash, so you can meet the sudden increase in demand.

Cons

Just like any other loan, there is some potential for risk. If you can't sell all the products, it can be hard to pay the loan back. And if you default on the loan, lenders might be wary about providing you with credit in the future.

Another thing to keep in mind is that wholesale inventory financing usually won't be enough to fully cover the cost of the products. This type of loan tends to come with higher fees and interest rates, and since most collateral depreciates, the lender will usually only give you around 70% to 80% of the product's value. You'll still need some other forms of funding to get your inventory filled again.

How to Apply for Inventory Financing

If you want to give this type of loan a try, you'll need to start by finding an inventory financing company that offers loans. There are a variety of businesses that offer inventory-based financing, ranging from online companies to established banks. It is common for businesses to shop around a little and find out which lender can give them the best loan.

Next, you'll need to start getting your finances and documents in order. You don't necessarily need a good credit score, but expect your rates to be quite high if your credit score is not at least in the 600s or 700s. Be prepared to offer a lot of details on your business' sales records and inventory system. You need to show that you're likely to sell the inventory and can keep it in good condition just in case the lender needs to collect the inventory. In addition to the normal documentation that most business loans require, inventory-based loans may also require things like warehouse inspections as well.

All of these steps can sound complicated, but in reality, most loan applications are quite simple. Your lender will walk you through the process and let you know what documentation they need. Just keep in mind that it can take a little time to finalize, so you should start the application process as soon as possible.

Ultimately, inventory financing can be a very helpful tool for expanding your business. As long as you approach it thoughtfully and don't borrow more than you can handle, financing inventory is a great way to generate growth. At Plastiq, we offer flexible solutions for modern businesses. Our services make it easy to send and receive payments while syncing with your accounting systems. To learn more about how Plastiq can help you, schedule a free demo today.