If your business is based on selling different products, it can be tough to finance the substantial amount of inventory that you need periodically. What’s worse, many lenders are hesitant about approving new and small businesses for that much credit because they are looking for more return on their investment. A good option to finance your inventory is through inventory financing.
What Is Inventory Financing?
Depending on what products you sell, as well as the overall size and popularity of your business, you may have to dedicate thousands, even tens of thousands of dollars a month toward inventory shipping and restocking costs. To help cover these costs
Inventory financing comes in two forms: an installment loan or a business line of credit. Both forms are secured against the inventory you buy. Inventory financing is generally beneficial to businesses that require large amounts of inventory. This may include restaurants, car dealerships, and retailers.
Asset-Based Financing vs Inventory Financing
With asset-based financing, anything can be used as collateral for the loan such as the equity in a commercial building or another valuable property, vehicle or piece of equipment. On the other hand, inventory financing uses the inventory you buy with the loan as collateral.
How Does Inventory Financing Work?
As mentioned, there are two forms of inventory financing. Both options can benefit your operations greatly and even help your business credit score. However, it’s important to choose an option based on the unique need of your business.
Inventory Financing: Installment Loan
An inventory installment loan works like a secured business loan, wherein a lump sum of liquid cash would be deposited into your bank account several days following approval. You would then repay your borrowings through divided installments, with the possibility of prepayments (earlier or larger installments). If you default on the loan, your lender can seize your inventory to recoup payment.
Benefits Of A Inventory Installment Loan
- Fixed Payments – These loans come with a fixed interest rate, so your payments will be steady and predictable, making it easier to budget for.
- Better Terms – Term loans may have shorter and more adjustable repayment plans than a line of credit.
- Lower Risk – Due to the inventory acting as collateral, the amount of risk a lender takes reduces. As a result, many lenders may approve you for a better interest rate and a larger amount of financing.
Drawbacks Of A Inventory Installment Loan
- Cost – Whether or not you use the entirety of your loan to purchase inventory, you’ll have to pay interest on the entire amount you borrow.
- May Impact Credit – Payments that are incomplete or missed may negatively impact your credit.
- Collateral – These loans are secured against your inventory. If you default on your loan, your lender can seize your inventory and sell it to recoup payment.
Inventory Financing: Business Line Of Credit
Rather than getting a lump sum loan, you can finance your inventory through a business line of credit. This will allow you to withdraw funds from a revolving line of credit, whose funds you can reuse as you pay it back. Interest is only charged on the amount you use and the principal doesn’t need to be paid until the draw period is over.
Benefits Of Inventory Financing: Business Line Of Credit
- Minimum Payments – Unlike the installment loan, you can make minimum payments with a line of credit to avoid defaulting.
- Quick Access To Cash – With a line of credit, you’ll have continued and instant access to cash (up to the credit limit).
- Interest – Interest will only be charged on the amount you use and not the credit limit.
- Variable Interest – Lines of credits typically have variable interest rates and may be lower than fixed rates when Canada’s prime rate drops.
Learn how to get the best rate for a line of credit in Canada.
Drawbacks Of Inventory Financing: Business Line Of Credit
- Fees – Some lenders will charge you an annual fee to borrow (many business loans have a few one-time administrative fees).
- Minimum Payments – If you choose to make the minimum payments only, it can lead to debts racking up and more interest.
- Higher Interest Rates – When the prime rate rises, your variable rate may be higher than a fixed rate.
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What Types Of Businesses Should Consider Inventory Financing?
As a business owner, you’ll have to think about where you will acquire the funds necessary to finance and move enough inventory. If it looks like you’ll have to spend too much personal income to make these purchases, it may be time to consider financing.
Inventory financing is a common solution for businesses such as:
- Wholesalers
- Distributors
- Manufacturers
Who Is Eligible For Inventory Financing?
While every lender has different approval standards, most will only consider your operation eligible for inventory financing if:
- The majority of your profits come from the manufacturing or reselling of supplies and materials to commercial customers.
- You have a viable inventory monitoring system, such as ‘perpetual inventory’.
- You can supply them with accurate financial statements.
- You own products that are easily and quickly marketable.
- Your business is currently approved for at least $500,000 in financing but still makes enough profit to consistently afford your payments.
How To Improve Odds Of Approval For Inventory Financing?
To earn high approval odds, a low rate, and a favourable repayment term, take these steps prior to applying:
- Check your credit report for errors and identity fraud
- Consolidate any outstanding debts
- Have a good credit score (Canadian business scores range from 0-100)
- Leverage your current inventory or other valuable collateral
- Get a business partner to cosign your application
Do you have bad credit? Check out how to get a small business loan with bad credit.
The Advantages and Disadvantages of Financing Inventory Purchases
Although there are other ways to pay for your inventory, financing it with a term loan or a business line of credit might be more cost-effective. However, it’s important to weigh the positives and negatives of inventory financing.
Advantages
- Large Loan Amounts – If you apply with a legitimate lender and have strong finances, you may get approved for more credit, lower interest rates, and better repayment conditions. Similarly, the more valuable your inventory/collateral is, the more credit you can acquire.
- Increased Purchasing Power – Having access to lots of credit can help you purchase and sell more inventory over a longer period of time than if you were withdrawing directly from your business income or credit cards.
- Free Up Cash Flow – Financing your inventory will free up cash flow which you can dedicate toward other aspects of your business.
Disadvantages
- High Rates – Shorter repayment terms typically lead to higher rates and larger installments, while longer terms can make your debt more expensive over time.
- Hard To Qualify – Qualifying is harder for businesses that are new, as well as those that have little existing credit, bad credit, or existing debt problems.
- Collateral – Applying for secured credit carries a significant risk for the collateral you offer (explained further below).
Learn how to manage small business inventory.
Inventory Financing FAQs
What is the “Due Diligence” process?
What happens if I default on payments?
What fees can I expect from inventory financing?
Bottom Line
If you’re interested in financing your inventory with a term loan or business line of credit, there’s no better place to apply than Loans Canada.
