Thanks to the rise of asset-based lenders over the last decade, many mid-sized companies have more financing options than ever. Unlike bank lenders, which rely heavily on the creditworthiness of the company in need to approve a loan or credit line, asset-based lenders rely on the financial strength and creditworthiness of the company’s customers while utilizing its assets as security for the financing. All a company needs to qualify for financing with an asset-based lender are reliable customers and its assets, which could include its inventory.
How Inventory Financing Works
Through inventory financing, a company’s inventory can be leveraged to provide immediate and ongoing cash flow as it sits on the shelves waiting to be sold. Typically set up as a revolving line of credit, inventory financing allows the company to draw requests for funds as they are needed. As inventory is sold, the proceeds are paid to the lender who then remits the balance owed to the company less finance charges. As inventory is added, the company can continue to request funding from its credit line. The credit line is tied to the amount of inventory on hand, which can grow or shrink depending on customer orders.
The typical amount advanced by a lender is 80% of the appraised value of the eligible inventory. However, instead of applying the market value to the inventory, lenders will use either the Net Orderly Liquidation Value (OLD) or the Forced Sale Liquidation Value (FLV), which can be substantially less than the market value. Eligible inventory includes finished products that can quickly be moved off the shelves.
Qualifications for Inventory Financing
Generally, the types of companies that utilize inventory financing are wholesalers, distributors and manufacturing companies with the following:
- A minimum of $500,000 in financing need
- Inventory of finished products or marketable raw materials
- An effective inventory management system
- Dependable financial statements
- No other option (have exhausted all other options such as factoring, asset-based lending, etc.)
Important Things to Know About Inventory Financing
Inventory financing tends to be more expensive than other forms of asset-based lending, such as receivables financing. For that reason, it is recommended that a company first consider the use of invoice factoring or receivables financing. Both are easier to implement and more cost-effective than inventory financing. Receivables financing can raise more cash more often because it is based on 70 to 80% of the invoice value. Inventory financing potentially raises less cash flow and only when inventory has been added. However, if, for any reason the receivables line is insufficient to meet the company’s needs, it could consider adding an inventory line on top of it.
At the very least, they should be used in concert with each other. An inventory financing line settles following the fulfillment of an order and after an invoice is generated. The invoice can then be financed to provide the funds to settle the inventory financing line.
Inventory Financing Requires More Due Diligence
Because financing inventory can be more complex than other financing methods, it requires more due diligence on the part of lenders, which increases the cost. The lender will want to review the inventory along with company’s facilities. Special attention is given to the company’s accounting and inventory system to ensure they meet minimum standards. In many cases, the lender uses a third party to conduct the review and appraise the value of the inventory. As long as the inventory credit line is maintained, the lender will conduct a regular review every three to six months. All of this adds greatly to the costs of inventory financing, which is why it should be used as financing method of last resort.
For companies that have larger financing needs and that maintain perpetual inventory, inventory financing is another arrow in their quiver of alternative financing options. When used strategically, especially in concert with other asset-based lending methods such as receivable financing, inventory financing can be a viable solution for meeting cash flow needs. However, when considering it as a financing solution, it would be important to perform a cost-analysis to see if other options would be more cost effective.