Inventory forms an essential part of the company's current assets. It accounts for goods that are held to meet short-term and long-term demand. Sometimes businesses may not be able to meet these demands owing to cash shortages or lack of inventory.
This can be due to late invoice payments, seasonal factors that affect business, sudden equipment breakdowns, or circumstances beyond their control. In such instances, an inventory loan can aid businesses in meeting their financing needs.
What is an Inventory Loan?
An inventory loan is essentially a short-term loan that is offered to retailers so that they can buy inventory. The loan is taken, keeping the inventory itself, i.e., the goods the business is planning on buying, as collateral. If the company is unable to repay this loan, the lender seizes its inventory and uses it for foreclosure. For instance, if a business takes an inventory loan to purchase a stock of bags but cannot generate enough cash flow to pay back the loan, the lender can legally seize the stocks for closing the loan.
Inventory loans are usually short-term loans taken to resolve inventory-based issues. Before providing the loan, the financial institution ensures that the inventory items being funded have good resale value.
Hence, this type of loan is not suitable for businesses that are new or do not have tangible products, or have products that may lose their resale value over time.
Why Choose Inventory Loans?
Ideally, businesses have cash in hand for daily expenses. There are situations where this cash may not be enough for the businesses to conduct their operations, especially when the cash flow is fluctuating. In such cases, companies might need to take in loans to restock their inventory, opting for inventory financing. One of the options in inventory financing is inventory loans.
An inventory loan is a type of loan where the business and the lender come to an agreement, stating that the company will repay the loan within the specified time with interest.
This is different from equity financing, where businesses get funding in exchange for an ownership share. This is also better than a line of credit, which is a revolving line of credit that gives them access to funds as long as they make monthly payments.
It is better to go for an inventory loan since it is non-revolving, providing a higher purchasing power to businesses along with a lower interest rate. The predictable payment schedule lets businesses plan out their finances accordingly, making it a better option for inventory financing.
With an inventory loan, businesses can fund their inventory partially, if not entirely. Since the collateral for this is the inventory itself, they do not have to provide any other company or personal assets. The basic idea of an inventory loan is that the firm takes the loan to purchase the inventory, which is then sold, and this money is used to pay off the inventory loan.
Hence, companies opt for import financing methods to meet their immediate inventory needs. Inventory loans prepare businesses to take on seasonal fluctuations or allow the companies to stock up for the busiest time of the year.
What are the Benefits and Uses of Inventory Loans?
Businesses in several industries, particularly retail, food, and wholesale, can benefit from an inventory loan. Inventory loans have several advantages.
1. Updating Product Lines
The most crucial aspect of every business is maintaining an adequate supply of inventory relevant to market trends. Companies look at the product categories performing well and stock up on those items. They may occasionally be unable to fund these due to financial fluctuations. With inventory loans, firms can buy more stock for the product categories they think will increase in demand shortly.
Along with this, businesses can also use inventory loans to expand their product lines. If they have excess demand, the company can add additional products that complement their best-selling products.
For example, if the best-selling products are phones, in that case, one can expand into supporting items like phone covers, earphones, ear pods, or headphones, because these are the products that consumers will eventually buy to use with their phones. Inventory loans allow businesses to expand into these new product lines and give firms the working capital to do the same.
Another concern that businesses may have is running out of cash to maintain the stocks of their popular products. Being out of stock when customers reach out to a business for their most popular item, may lead to customers turning to competitors instead. This may lead to businesses losing loyal customers. Inventory loans can help here as they allow businesses to overcome the challenge of being understocked.
2. Less paperwork
Obtaining loans for any reason can seem complicated, but an inventory loan involves less paperwork. Sometimes a company needs cash quickly to buy goods, but applying for a standard loan may take time and effort. Inventory loans are a convenient choice, given the limitation of time and resources.
3. Improved cash flow
The most crucial factor for a business’s health is its cash flow. Companies have always been cautious about their cash inflow. Since the pandemic, they have been even more prudent about their financial flow and inventories. With the economic environment becoming so unstable and unpredictable after the pandemic, businesses feel more secure with an inventory loan in case of unforeseen circumstances.
It makes sense to use the money from the inventory loan when the economy is unstable. For instance, in a wholesale industry, buying in bulk comes with challenges. However, the cost of arranging such large purchases can be high, and not all businesses would be able to do so without an inventory loan. With an inventory loan, the warehouses can be stocked entirely for the foreseeable future.
Do all Businesses use Inventory Loans?
Most inventory loans are taken out by small and mid-size retailers. This is because they don't have the kind of solid financial foundation that more established companies may have. Most small businesses do end up using inventory loans to operate their company, but there is a risk involved.
While they work to build an eminent reputation for themselves in the marketplace, new firms run the risk of becoming heavily indebted. Their liabilities may increase as a result of this inventory financing, and if they are unable to pay back the loan, things will only become worse.
Therefore, companies that have been in operation for more than a year will have more stable financial positions and be more likely to take out loans for inventory finance.
What Types of Businesses Utilize Inventory Loans?
Different businesses utilize inventory loans for different purposes. While one business would need to take an inventory loan to expand its product lines, another could be taking it to meet the immediate demand for products.
- Retailers
An inventory loan is a feasible option for retail stores such as jewelry stores or clothing stores to keep up with trends and keep their stocks up to date. This enables them to buy in bulk from a wholesaler, where they may pay in advance and receive discounts on the purchases.
As a result, they will be able to accept large orders from their clients. Additionally, firms may currently be using manual, non-automated methods to track their inventory. One can get current inventory software using inventory loans, which will assist them stay on top of their inventory.
- Wholesalers
Inventory loans enable them to meet unforeseen wholesale order requirements, assisting them in overcoming supply and demand issues. Regardless of how much working capital a wholesaler currently has, inventory loans provide them with the necessary working capital to stock up on inventory. Since they don't have to wait for payment from the retailers, inventory loans cover the first purchases, assisting in maintaining the company's cash flow.
- Seasonal businesses
Seasonal businesses are highly prone to facing inventory issues. Since their products don’t sell uniformly throughout the entire year, they must always be prepared for wild fluctuations in demand. This requires them to purchase their products in bulk ahead of the season when they might not necessarily have the funds required. In this case, inventory loans are the best option. For instance, if a business sells surf boats, they might only peak in the summer, when it is surfing season.
How to Apply for an Inventory Loan?
As mentioned above, inventory loans involve less paperwork than other types of inventory financing. But there are eligibility criteria for one to be applying for the loan as well as a few documents which are required for the same. Let's look into it more in detail.
Pre-requisites
Businesses being at least a year old Businesses should be at least a year old to increase the chances of getting the inventory loan approved. Being in business for a year generally indicates that the business can sell the inventory, which assures the lender. Companies that are just starting may not have a good sales record, so their chances of getting the loan approved reduces.
Sales record Having a good sales history helps get the loan approved. Since the entire purpose of the loan is to increase sales through which the loan will be paid back, it makes sense for the lenders to go through the revenue history.
Systematic inventory management Lenders expect detailed inventory reports and updates from the borrowing business. This is because they want to know that the company is monitoring its stocks. This is also important because businesses must provide the lenders with proof that the inventory is regularly converted into cash.
Steps to start filing
- Compiling all Business Documents
The lender will have a detailed look at the business' financial bookkeeping. Hence it is of utmost importance that the company keeps the following records ready
a)Balance Sheet b)P&L Statement c)Business bank statements d)Inventory list and management records e)Cash Flow Statement f)Sales Forecast g)Tax Returns
- Completing the Application
After cross-checking the borrower’s documents list, the next step is for the borrower to fill out the form and submit it. Some lenders have an online form that asks for essential details such as business name and the amount the borrower would need, among other things. After the form is submitted, someone from the lender's team will connect with the business to explain the due diligence process.
- Performing Due Diligence
This is the process where the firms' assets and liabilities are thoroughly checked. Since due diligence might take a lot of time, it may be the cause for some delay in the process. Usually, the due diligence process takes up to 45-180 days. Hence, few lenders ask the firms to agree to a preliminary commitment. This lessens the risk for the lender if the firm decides not to go ahead with the loan after due diligence is conducted. This process involves a field visit. So, borrowers need to submit a field audit of their business.
- Reviewing the Preliminary Offer
Once the above process is completed, the lender will present a preliminary offer. This is not the final offer but just an initial proposal, which the lender provides to borrowing firms, that the businesses can use to preview the amount and terms. If the business wants to go ahead with this preliminary offer, it can pay the due diligence fee to show commitment and intention to proceed with the loan.
- Signing the offer
Once the preliminary offer is reviewed by the borrower, they can sign the request and get funding. Once the documentation is done, funding is processed in a matter of days.
Difference between Inventory Loans Vs. Inventory Lines of Credit
What are Other SMB Loan Options?
There are several alternatives to Inventory loans that businesses can opt for. Few of the most popular options include-
1. Term loans
Inventory loans are loans that businesses take to finance their inventory, whereas term loans are loans where the borrower takes up upfront cash in exchange for specific borrowing terms. Companies usually take term loans to invest in fixed assets such as a new building or equipment, unlike inventory loans, which are specifically meant for inventory.
2. SBA Loans
Small business administration (SBA) is a US government agency that provides financial assistance to small businesses. The government partially guarantees these. Unlike inventory loans, SBA loans come with lengthy paperwork compared to much quicker inventory loans.
3. A business line of credit
A business line of credit, like a credit card, gives users access to revolving credit through a checking account. In contrast, an inventory loan is a non-revolving loan that the firms take specifically for inventory issues.
4. Equipment loans
Loans used to buy equipment for a firm are known as equipment loans, except for real estate, this equipment can be any tangible item. These pieces of equipment can be anything ranging from complex machinery to desks and chairs. Firms prefer equipment loans when they want to upgrade and expand their businesses.
5. Microloan
A microloan is a small amount of money loaned to businesses in the US. These loans are typically given to people or organizations with financially developing backgrounds. Usually, these loans are availed by people with low capital requirements. The objective of microloans is to promote startups, unlike inventory loans, whose aim is to meet short-term or long-term inventory goals.
Mostly, the need for inventory financing is a good thing. This is because it indicates that a business is doing well enough to prepare for future demand increases. This further means that it has good market value and customer loyalty. There are alternatives to inventory loans for small businesses, as mentioned above, but inventory loans seem suitable for the sole purpose of resolving the inventory-related challenges.