Inventory Financing: Your Guide To Inventory Loans

You’re a business owner with a successful product and you’ve got a plan to expand your company. Whether you’re trying to add new products to sell or you need to increase your inventory to keep up with a busy season, you need some way to pay for the inventory. 

Welcome to Inventory Financing 101! One of business’ best tools to increase cash flow, increase warehouse stock, and make higher sales is getting someone else to fund your inventory while you rake in the revenue. 

Inventory financing may not be a one-size-fits-all solution to your business needs, so stick around and we’ll explain some other ways of financing your business at the end. 

What is Inventory Financing?

You have probably tried to think of any way to increase your inventory without taking out massive amounts of debt. Most of the time, it’s not that simple or practical. Inventory financing is a type of loan that allows you to take out a loan against your inventory in order to fund the supplies or raw materials. Your inventory becomes your collateral. But there are different types of inventory loans that are more flexible and may work better for your business. 

Types of Inventory Financing:

1. Term Loans
2. Lines of Credit
3. Revenue Based Financing
4. Invoice Financing

1. Term Loans

Most of us know what term loans are if we’ve ever financed a car or taken out a mortgage. These types of loans have a set number of months where you pay a fixed minimum amount every month. 

These are probably the most common type of loans because they can be worked into a monthly budget without pop up expenses. 

Example: You take out an inventory loan for $10,000. Every month you make a payment of $500 until the debt is resolved. Without adding in interest, it will take you 20 months to pay back the loan. 

However, term loans don’t leave much room for flexibility. Once you spend the money it’s gone and you’ll have to reapply for another loan if you need more funding. 

2. Lines of Credit

Some suppliers will offer a line of credit inventory loan option to their customers. This allows you to buy the product on credit and set up a monthly payment similar to a term loan. The difference is that as you pay back the loan, the credit becomes available to you again. 

Example (for this example we’re going to forget interest is a factor): You receive a line of credit for $5,000. You use all of it to purchase your inventory. When you make your sales, you are able to pay back $3,000 on your first payment. You still owe the remaining $2,000, but your payment frees up $3,000 of credit for you to use on more inventory. So you take $2,000 of the remaining credit and purchase a new line of products. Now you owe $4,000, but you still have a remaining $1000 in credit from your first payment. 

We know, that’s a lot to follow. Basically it’s kind of like a revolving door – meaning you use and incur the credit over and over. 

3. Revenue Based Financing

Revenue based financing is probably one of the most flexible options when it comes to inventory lending. The lender will provide the money up front and as you make sales you’ll pay a percentage of revenue back to the lender. 

Revenue based financing looks like this (again, forget interest is a factor):

• Day 1 – Your $10,000 loan is funded at 15% RBF rate, and you purchase your inventory. While you wait for your product to arrive, you’ll promote, drive traffic to your store, and take invoices. 
• Day 30 – Your inventory arrives and you begin shipping orders. You received $5,000 in revenue so your 15% cut to the lender is $750. It’s okay to have a slow month. Customers are still finding your store and product if you are new to eCommerce. Keep advertising. (Remaining balance due: $9,250)
• Day 60 – The customers find your product and you sell $15,000 in revenue so you pay $2,250. (Balance due: $7,000)
• Day 90 – Look at you! You sold $25,000 in revenue and paid back $3,750. (Balance due: $3,250)
• Day 120 – Another great month! $27,000 received and you pay off the RBF loan. (Balance due: $0, plus you have $800 to add back into your revenue).

You made $72,000 in revenue. After you pay back the $10,000  loan in full you still clear $62k. 

Of course, this is just an example that doesn’t show the effects interest has on repaying the loan. But what this example does show is that it can be easier for some businesses to budget around this type of repayment plan versus a hefty monthly installment. Think about it this way – if your term loan was to be paid back at $2,000 per month, after the first 30 days you wouldn’t have been able to make that payment. 

4. Invoice Financing

Another creative way lenders have been able to help sellers around the strict monthly payment plan is with invoice financing. This type of loan is commonly issued as a line of credit, and paid back by using your invoices as collateral. The lender will take an average of the previous months’ invoices and issue 70-90% of the amount. 

Invoice financing looks a little like this (again, suspend reality to make interest go away): 

• Day 1: You borrow $10,000 and get the money up front. You are able to order your inventory, but the current invoices you have that total $10,000 are now the collateral. When those invoices are paid, you will pay the financier. 
• Day 30: 70% of your customers paid their invoices in full and on time. You are able to pay the financing company $7,000 toward your loan or line of credit. Depending on the terms of your loan agreement, you will have time to pay the remainder of your loan over the next few months at an agreed percentage of the invoices (for this example we will say the agreement is 15%). (Balance due: $3,000).
  • If the agreement was for 30 days, and the loan has matured, the financing company will seize the remaining $3,000 of current invoices that have been received from customers. You will not be able to collect on these invoices until the balance has been paid. 
• Day 60: 20% of your unpaid invoices have been finally paid in full and you have also received payment for last month’s invoices that totalled $5,000. For the month, you received $7,000 in payments. You still owe $3,000 and the invoice financiers are going to take 15% of the payments from your invoices until the debt is paid. This month you’ll make a payment of $1,050. Total paid to the lender so far: $8,050. (Balance due: $1,950).
• Day 90: The final 10% ($1,000) of the invoices from the original collateral still have not been paid. You sell the debt to collections for 4% ($400). You’ve also brought in $15,000 this month. 15% of the total income is $2,310 – but you only owe $1,950. So you’re able to pay the balance of the loan and put $360 back into your revenue. 

On the surface, invoice financing and revenue based financing look very similar. You could have an offer for an  RBF loan for $10,000 at 15% and another offer from an invoice financing company for $10,000 at 15%. You are still paying back the loan with interest as you make sales (or incur invoices), but instead of collecting a percentage after the product is sold your invoices are held as collateral – meaning the financing company won’t seize your inventory, they will seize your invoices. They don’t want to go through the hassle of repossessing your product and selling it themselves or to a supplier. They want their money. 

Who Benefits from Inventory Financing?

The easy answer? You do! Businesses that produce a product benefit from inventory financing because it gives you the option to procure your product or supplies without putting up the money up front for your own product.

However, there are circumstances where inventory financing doesn’t work for every business. For example, a company that does not sell products would not benefit from an inventory loan. There is nothing to put up as collateral for lending companies. 

Pros of Inventory Financing

As we’ve talked about throughout this article, there are many benefits to inventory financing. Let’s expand on the pros:

• You get funding up front: You don’t have to wait for the loan to come in installments. You get all the money up front to use right away.
• Ability to increase inventory: During a busy season, like around the holidays or during an especially hot sale, you can increase your inventory or add products to your product line. After researching the market and you determine what the next hot seller is, you can purchase that line of inventory to add it to your stock without having to stress about having the money up front first. 
• Relatively quick and easy to apply: Most lenders do business online these days which makes for an easy and convenient process for the applicant. Inputting the information takes a few minutes and you get your approval in minutes. Customer service for the lending department is also available to answer any questions or problems you uncover. 
• No personal collateral: With inventory financing you don’t have to worry about losing your house, car, or other personal assets. Since your inventory is your collateral, the lending company will seize your product should you default on the loan. 
• Several options to fit your needs: As discussed previously, there are several types of loan options to fit your business needs. Term loans, lines of credit, revenue based financing, and invoice factoring provide different ways to pay back your loan. Whether you prefer to make the same payment every month (term loans and lines of credit), you decide to pay back a percentage after each sale (revenue based financing), or you find that selling your invoices works best (invoice factoring) there is a flexible option to look into for everyone. 
• No need for high personal credit: Credit is still an important factor, but securing the financing through your business means the lender may not need to check your personal credit history. You won’t have a hit on your Experian credit report and you won’t be held personally responsible for the loan (although your business will be responsible and if you are responsible for the business you need to take precautions to separate your personal credit from the company).

Cons of Inventory Financing

With every good reason for choosing an inventory financing option, there are also factors to consider. Here are a few cons you should keep in mind while choosing the best financing option for your business. 

• If you don’t pay, they take your inventory: Your inventory is your collateral, so if you don’t pay they take your products and you have nothing to sell to your customers. This could put you in a bind because without your product, what reason do the consumers have to come to your website or online store? This is a good lesson in not getting in over your head. Just because the lender offers you $1 million doesn’t mean you have to take that much. 
• Interest rates can vary (4-99%): Sadly, there is no consistency among lenders. Most of them will advertise interest rates “as low as” 4%, but in reality there are many factors that influence your individual rate. This includes everything from customer demand for your product all the way up to how much money the government is borrowing at the time. With consideration for inflation and the foreign currency exchange, you could be looking at rates up to 99%, which is absolutely bonkers in our opinion. But there are a few things you can control – clean up your business credit by settling debts, make sure you are purchasing inventory that has proven to do well in the market, and have a backup plan if the interest is too steep for your budget. 
• Only used for inventory: It’s called an inventory loan because you can only use it for inventory. If you’re trying to remodel the office or catch up on payroll before hiring new employees for a busy season, you’re going to need to find another option. But for businesses who sell products, freeing up your budget for inventory by taking out an inventory loan could improve your cash flow significantly. 

What Are The Other Options For Financing Your Inventory? 

If inventory financing doesn’t sit right with you and your business, or you’re looking to split the loan between your inventory and your payroll (or other areas of business), you have a few other options to look at. 

Each type of financing has its pros and cons, so careful research of the terms, conditions, interest rates, and penalties is vital. 

Merchant Cash Advance

One of the best options for many small businesses is the option merchant cash advances. An MCA company will lend you the money up front to fund your supply chain from beginning to end. 

Sounds too good to be true right? Well, it’s actually a simpler form of lending because you don’t have to think about the loan constantly growing due to compounding interest because MCAs use factoring instead of interest. Factoring companies calculate your factoring rate based on the type of business you do, your credit and debit sales, and your credit history. 

Once your loan is approved and your factoring rate is determined (usually somewhere between 1.1-1.6% of the loan) that is the final amount you will repay whether it takes a few months or over a year. So if you borrow $50,000 at a factored rate of 1.5%, the MCA company stops withdrawing payments once you reach $75,000. 

Payments are made when the MCA company deducts a set percentage from your daily or weekly sales transactions. Fixed payments can also be deducted from your business account on a daily or weekly basis without considering sales. Fixed payments are based on your revenue. 

Many businesses benefit from MCAs because they can finance the whole supply chain from production and advertising to shipping and handling returns. Other options can be strictly limited to inventory and MCAs give you the freedom to designate the money where you need it most. 

Invoice Factoring

We know what you’re thinking, we already talked about this one earlier – but look again. We actually talked about invoice financing. Invoice factoring has a very similar structure but you’re not limited to using the money on inventory.

Instead of using your invoices as collateral, you actually sell the invoices to a factoring company who then will collect on the payments from the customers directly. Invoice factoring can be tricky because the lender does not wait for you to receive payment from the customer first nor do they act as a debt collection agency. They either receive the money for the invoice through the customer or they send the dud back to you and charge you for the missing percentage of your payment. 

Bank Loans

If you decide not to go through a supplier or inventory financing company, banks are one of the most popular choices for term loans and lines of credit. The interest rates are usually lower, but banks are pickier than other business lenders. You may have to jump through hoops, improve your credit significantly for them to even look at you, and put up personal or business assets as collateral. 

Additionally, you can blur the lines with bank loans by taking out a personal loan for business use. If your business is very new or doesn’t have established credit yet, this might be an option you look into. You will need to disclose this to the lender and will likely need to put up personal collateral. Most people do not like to go this route because it puts them at risk of losing their personal assets such as their house or car. 

SBA Loans

The Small Business Association (SBA) is one of the first stops for many businesses that are looking for financing options. The SBA can offer loans that are at higher risk to them than banks are willing to take on. Additionally, they can sometimes offer lower interest rates. 

Small businesses love SBA loans. The SBA doesn’t actually lend money directly, but they do back the loans given out by SBA-approved lenders. These loans are guaranteed up to 89-90% of the loan amount which is why both businesses and lenders love this option. 

Grants and “Free Money”

Government-backed and SBA grants for small businesses are highly competitive, vary in amount, and often include some restrictions or requirements for approval. If you meet these qualifications and are selected, you get the money with no need to pay it back. 

Grants are basically like what we had to do in high school when we were applying for scholarships. You have to stand out from the crowd because only a small number of businesses receive these grants. 

It’s important to note that there is really no such thing as “free money.” You could save every penny and rely on interest but there could be penalties associated with early withdrawal from a CD, government bond, or retirement. In the case of government bonds, your penalty is the forfeit of future interest that could accrue (bonds accrue interest for 20-30 years depending on the series). 

Alternatively, you can take on investors, people who will give you a designated amount of money for a share of your company. If you’ve ever seen Shark Tank, you know what we mean. The only problem is that once you take someone’s money, they have a say in how you spend it – much like some terms of a loan or grants. Investors can provide the perfect opportunity to increase your cash flow but it shouldn’t just be a verbal agreement between friends or family members. 

You need to establish clear boundaries and terms for their investment:

• How long will the investor collect on their return?
• What role will they play in the business?
• What decisions are they allowed to make without you? 
• What decisions do you need to consult with them about? 

Finally, let’s not forget about credit cards. The right business credit card can offer you a line of credit at the swipe of your card. Making purchases is fast and easy. Interest rates and offers can vary from lender to lender, but generally you can shop around online to find the best rate. 

Many lenders offer special bonuses when you open your business credit card. You can earn points, cash back, and other rewards for using your credit card. But many people worry about using credit cards because it can be easy to spiral into debt. Take care when choosing the right card. 

Conclusion

Inventory financing is a very attractive option to businesses looking to finance the production and/or procurement of their stock for sale. You use your inventory as collateral so your personal assets remain secure. But inventory financing isn’t the only option. Traditional bank loans, SBA loans and grants, lines of credit, credit cards, and invoice factoring are excellent alternatives. Additionally, taking on investors, applying for grants, and cashing in your government bonds or CDs are less risky for you. 

In whatever way you plan to finance your inventory, a successful loan is the one you pay off.