Inventory Loan | 4 mins read

Inventory Loan- Is It Right For Your Business & How Can You Apply?

inventory loan is it right for your business how can you apply
Jin Hyun

By Jin Hyun

Inventory loans can be a lifeline for businesses that need to purchase stock to meet sudden or seasonal demand. Learn how they work in this brief guide.

Inventory management plays a crucial role in preventing stockouts, maintaining accurate records, and keeping operations in multiple locations running smoothly.

But even thriving businesses that carry large quantities of inventory will sometimes need more stock to weather fluctuations in product demand. In fact, a Harvard Business Review report puts the average global stockout rate at 8%.

In cases like these, asset-based financing options, such as inventory loans, let businesses acquire inventory in a pinch.

What is an Inventory Loan?

An inventory loan is designed to give small businesses an infusion of capital to acquire inventory. It is a debt instrument that legally obligates the borrower to repay whatever amount a lender agrees to loan over time, with interest.

Businesses typically use these loans to purchase inventory for the following reasons.

  • Buy stock in bulk - Cash flow constraints can prevent businesses from buying goods in bulk to achieve economies of scale. A line of credit to finance bulk inventory purchases solves this problem.
  • Prepare for peak season - Using inventory loans (or any other type of business loan for that matter) during a less busy season allows you to quickly buy inventory ahead of peak periods. This puts businesses in a better position to meet demand when sales begin to speed up.
  • Boost margins by purchasing stock at low prices - An inventory loan allows businesses to take advantage of time-sensitive opportunities, such as closing sales or seasonal offers, when cash flow is low.
  • Maintain cash flow during low sales periods - An injection of capital can help the enterprise keep going during slow months.
Despite their usefulness, inventory financing loans are not for everyone. In fact, a PwC report shows that only 16% of respondents used inventory financing and asset-based lending in their supply chain financing programs. The reason is simple - inventory loans cater to specific types of businesses.

For starters, these loans are generally not for startups as lenders look for borrowers with an established record of buying inventory. But they're not entirely for established enterprises either.

Inventory loans are typically used by businesses that have large amounts of money tied up in inventory - think manufacturers of fast-moving consumer goods, retailers, and food and beverage companies.

Pros and Cons of Inventory Loans

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As with any business financing option, inventory loans come with its fair share of advantages and disadvantages.

Pros of Inventory Loans

  • Inventory financing is useful for businesses that need to pay for inventory that has to be stocked for a period of time before being sold to customers.
  • For businesses that don't have assets (apart from inventory) to use as collateral, inventory financing can be an attractive option.
  • These loans are ideal for businesses with overseas suppliers. This arrangement often leads to delays between paying for and receiving inventory.

Cons of Inventory Loans
  • Inventory loans usually come with higher interest rates, more so if the business's credit score isn't great. Be sure to compare the total cost of the loan with the potential profit from acquiring inventory.
  • Inventory loans take lots of work. Business owners must do their due diligence in ensuring that their financials, revenues, profits, and personal credit score are in great shape. Go over inventory records carefully as this is something lenders will check.

How Inventory Loans Work

With inventory loans, a traditional bank lender will usually present two options- a lump sum of cash or a line of credit. Either way, the loan line of credit is generally based on a percentage of the company's inventory value, with the inventory itself serving as collateral. This means there's a risk of surrendering stock to finance lenders should the enterprise default on the loan term.

Inventory loans are typically offered as short-term debt instruments, with repayment periods of anywhere from three to 12 months. The idea is to use the loan to purchase inventory and use the proceeds to pay off the expenses as soon as possible. The longer a business holds on to inventory, the more they'll incur storage costs and hold up working capital.

Lenders have different terms and requirements to qualify for inventory loans, but business owners can generally expect the following-

  • Annual percentage rate (APR) - 9% to 99%
  • Minimum annual revenue - $50,000 to $250,000
  • Minimum personal credit score - 500 to 600 (lower scores incur higher APR)
  • Minimum required time in business - three months to two years

Applying for an Inventory Loan

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First things first- shop for a lender. It's a good idea to look for lenders offering loans to businesses in your industry. These lenders will know how to estimate the value of your inventory, which goes a long way towards speeding up the process.

With inventory loans, lenders typically ask for recent versions of these documents-

  • Balance sheet
  • Profit and loss (P&L) statement
  • Cash flow statements
  • Inventory records
  • Personal and business tax returns going back at least one to two years
  • Business bank account statements
Assuming everything checks out with the lender, the loan is approved and both parties move to the funding stage.

Inventory financing can be a useful lifeline for businesses with seasonal cash flow challenges and unexpected inventory problems. But like any other type of business loan, they come with their risks and benefits. Be sure to do your homework and understand what you're getting into before signing the dotted line.