What is Inventory Financing & How It Works?
What Is Inventory Financing?
Inventory financing is a short-term, asset-backed financial solution that a firm can use to cover non-inventory-related expenses. This solution is offered to small and medium-sized shops or wholesalers with a large inventory. To use this benefit, a borrower must give business goods as collateral to gain funds and cover costs.
But if the merchant can’t repay the loan on time, the moneylender can take the inventory or any other inventory of similar value. Since inventory is so important to inventory financing, the financing company must ensure that the inventory has a good resale value before giving the loan.
As a result, this financing arrangement is inappropriate for businesses that are new to the market or do not have real products in their inventory.
Types of Inventory Financing
A business can apply for any of the following inventory financing options:
Inventory Loan
When a business needs money quickly and plans to use the value of its inventory to get it, this type of financing is a good choice. An inventory loan can only be taken out once.
Inventory Line of Credit
This is more popular with businesses because it can be used to pay for unplanned costs after the borrower gets the loan. In this financial arrangement, the lender gives the borrower money whenever needed.
Inventory Financing Eligibility Criteria
When getting a loan through this program, borrowers must keep the following in mind:
- The company should have been in operation for at least a year.
- The company applying for this financial scheme must have a good turnover.
- The company must have a good business credit history.
- The borrower should have a successful business sales record.
- If a company has a mature product and little debt, there is a good probability that the merchant will get a loan to finance their inventory.
- The business should not have committed severe credit violations like bankruptcy or repossession.
- If a company has an aging inventory or wants to take out a long-term loan, its loan application will be declined.
Documents Required for Inventory Financing
You’ll have to submit the following documents if you decide to use this short-term funding arrangement:
- Applicant’s Driver’s License
- Cancelled Business Check
- Bank Statement
- Business Balance Sheet
- Company Registration Information
- Appraisal Report
- Business Profit and Loss Statement
- Business Tax Returns
- Supplementary Documents
- Copies of Sales Invoices
Things a Bank Will Look At
- Economic, Business, and Industry Inventory Sequences
- Inventory’s Value for Reselling
- Limitations in Logistics and Shipping
- Stock’s life and how quickly it goes bad
- Provisions for theft and loss, and much more
How Does Inventory Financing Work?
Inventory financing can work in two ways. A bank can give you a term loan or a line of credit to buy things.
The difference is that a term loan gives you the whole amount of money upfront. You usually pay back the loan in fixed monthly payments over a certain period of time.
On the other hand, a line of credit is used to buy things as they become available. In this case, you only pay interest on the part of the credit line that you use. And when you pay off your debt, your credit limit will return to what it was before.
Here’s an illustration of how it might function. Assume you must buy INR 6,00,000 in inventory to prepare your firm for peak season. You contact a lender who assesses your assets’ liquidation value to be INR 4,50,000.
Suppose the lender offers to lend you 80% of that amount, or INR 3,60,000, at a fixed 17% interest rate. Assume you spend the entire INR 3,60,000. Then, you would have to repay INR 4,21,200 (INR 3,60,000 plus INR 61,200 interest) over the course of 12 monthly instalments. That equates to INR 35,100 per month.
You repay the loan in full after 12 months. You now have full access to the 3,60,000 INR and can purchase items as needed.
Assume you get a better offer by buying in bulk. You decide to withdraw INR 50,000. You’d still have access to the remaining INR 3,10,000. If you repaid the INR 50,000 you borrowed, your credit limit would be reset to INR 3,60,000.
With either method of financing, the inventory you purchase serves as security for the loan.
Your lender determines the amount you can borrow. For example, Lender A may allow you to borrow up to 100% of the liquidation value of the inventory. However, Lender B may only let you borrow up to 70% of the liquidation value. Lenders usually require professional assessments to determine the liquidation value of any goods you intend to purchase.
Things to keep in mind
- Few private and public sector banks and non-bank financial companies (NBFCs) don’t offer inventory finance because they don’t want to collect and keep collateral that isn’t useful to them in case the borrower doesn’t pay back the loan.
- Over time, the value of any stock tends to go down. So, it’s possible that the borrower won’t be able to get a loan for the full value of its stock.
Conclusion
When they need emergency credit, many retailers, manufacturers, and dealers choose inventory financing because it immediately gives them access to cash. Inventory financing is a good way for businesses with large inventories to get funds at a lower rate. It is a type of asset-based lending that is efficient and reliable.
This financial solution helps small and medium-sized businesses increase sales and operations, improve cash flow, and prepare for peak season. This financial solution can help merchants with short-term cash flow problems and help them buy more inventory.
Contact Piramal Finance for great deals on inventory financing.