What is an Inventory Line of Credit?
An inventory line of credit (LOC) is a form of short-term financing specifically designed to help small businesses buy the inventory they need, when they need it. The credit line is typically based on the strength of a company’s sales and can range from $50,000 to as much as $500,000. Once established, a company can request a drawdown that can be received in as little as two or three days. The company’s on hand inventory and/or the inventory being purchased is used as collateral to secure the amount borrowed.
Interest rates on this type of financing are typically much higher than on traditional loans, but companies should only be borrowing amounts they expect to repay within a short period of time. The ability to control the amount borrowed and repay the loan quickly makes the inventory LOC much more desirable than trying to obtain a fixed, longer term loan.
How to Qualify for an Inventory LOC
Inventory LOCs are ideally suited for smaller companies with less than stellar credit or short operating histories. The lenders that offer them are generally non-bank alternative financing companies, also referred to as platform lenders because they offer a completely turn-key process for applying for and obtaining financing on line. Most platform lenders look first to a company’s sales track record and projections because that is how they measure their risk. Companies with poor or no credit can still qualify for an LOC if they have strong sales. However, lenders will also consider the owner’s personal credit score in determining the interest rate. The actual requirements vary among the different lenders, however, these could be considered the minimums:
- Good personal credit – credit score of 600+
- $60,000 of annual revenue
- Six to nine months of operating history
The annual percentage rate (APR) and the size of the LOC are determined based on these requirements. Higher credit scores and annual revenues and longer operating histories will warrant consideration for a lower APR and higher LOC.
In addition, companies may be required to demonstrate a solid foundation in inventory management. This could include having an effective inventory management system in place; being able to present accurate business records and an account of the total inventory; and ensuring the warehouse facility is properly structured and maintained. All of this should be done in anticipation of an onsite audit performed by the lender or a third party.
When Inventory Financing Might be the Best Option
Inventory financing can be the ideal solution for growing businesses that need access to a reliable source of capital. Businesses with weak sales or slow-moving inventory, though they might be in need of capital, could find an inventory LOC more of a burden if it can’t be repaid quickly. Conversely, business with strong sales and a high turnover rate could profit from a properly managed LOC. A business is a good candidate for an inventory LOC under the following circumstances:
- The business needs an infusion of capital to restock its inventory ahead of heavy sales season.
- The business could benefit from having a flexible form of financing available to smooth out cash flow and cover ongoing operating expenses.
- The business has an opportunity for a major inventory purchase at a steep discount and needs additional capital.
Small retailers, manufacturers and distributors with strong sales growth can benefit from inventory financing. The ability to have just-in-time financing available for inventory needs can make far more sense for a company than trying to obtain longer-term financing. Companies don’t have to be concerned with having to tell customers they are under-stocked or sold out, or being able to pursue a big order or new customers, because the capital can always be available to meet the demand. When used properly, inventory financing can be an effective financial management tool, enabling a business to better control cash flow and keep more of its own capital working in the business.