What Is an Inventory Loan? Should You Get One?
Product-based businesses rely on having inventory on hand or easily accessible. If you’re unable to provide people with what they need quickly, clients will go elsewhere.
So what’s a small or medium-sized business to do when they don’t have the funds to invest in inventory?
It’s a Catch-22. You need the product to sell, but you have to have working capital to buy the product.
That’s where an inventory loan can help.
An inventory loan is a viable option when you need your wholesale shelves stocked or enough product to cover a major order.
Designed for small businesses, the terms are flexible and short-term. But even with these advantages, there are some things to consider before you apply for inventory financing.
This guide breaks down the pros and cons of inventory loans to give you the whole picture. From there, you can decide if it’s a funding option that’s right for your business needs.
1. What Are Inventory Loans?
Inventory loans fall under the category also called “inventory financing.” They are any type of funding borrowed by a business to buy products they plan to sell in the future.
The products are the inventory that becomes the loan’s collateral.
Because the funds are secured, there is less risk to the lenders. Companies that pay vendors and suppliers for their crucial stock turn to inventory loans when working capital is tight.
However, the funding isn’t meant to be a long-term loan.
The terms usually come with short repayment periods. They work well when a business is experiencing seasonal dips or needs extra inventory quickly.
Inventory Loans Vs. Inventory Lines of Credit
Lenders come in two main varieties with this type of financial solution. Business owners might take out an inventory loan or benefit from an inventory line of credit.
It sounds like a slight distinction. There’s a big difference in the terms, though.
Inventory Loans Explained
As the name implies, an inventory loan is given to small businesses with the intent of purchasing product. It’s a flexible type of funding that covers various goods or supplies.
Here are a few examples of an inventory loan used to its best advantage:
- A startup business that only needs to stock up on inventory to start selling its product
- A small grocery store owner dealing with a seasonal lull and empty shelves that need restocking
- A clothing retailer getting ready for the holiday season by trying to stock the latest fashions
In each of these situations, the business owner is low on cash flow but expects profits soon. They’d be able to handle the loan’s repayment terms when their sales increase because of their new inventory.
The main thing to be aware of is that the funding is a short-term loan with fees and often hefty interest rates. Depending on the loan amount, an average repayment period could be anywhere from 3-12 months.
The expected annual interest rate would range from low to significantly high (4% – 99%). They determine this rate by the company’s financial history, credit score, and length of time in business.
Some companies won’t lend to a startup, requiring a minimum of six months before they’ll approve the loan.
Inventory Lines of Credit Explained
The other alternative is an inventory line of credit. These are similar to credit cards in that small business owners have a limit they can borrow up to. Instead of taking out a lump sum, they pull from that pool of money when they need access to the cash.
It’s a form of revolving credit. Once they repay the amount borrowed back to the lender, they can access the total limit again until the term ends.
The business owner can repeat this cycle over and over, as long as they make the minimum payments. Interest is only charged on the amount borrowed rather than the entire loan.
When the line of credit expires, the full amount due is broken down for repayment as with a bank loan. The interest rates tend to be high, and it can take five to seven years to get rid of your monthly payments.
Inventory lines of credit are beneficial to companies with a lot of inventory turnover or seasonal working capital shortages. They can pull from the funds in limited amounts and then repay them during the busy season without accumulating a sizable debt.
Related: Are Grants Always Better than Loans?
2. How Does Inventory Financing Help?
Running a business means you’re going to have ebbs and flows. Even major corporations know and prepare for this. One of your strategies to survive the slow periods could be inventory financing.
With a financial backup plan, you’ll be able to satisfy your current customers and prepare for future sales. And there are lots of advantages that make this type of economic solution tempting for small-to-medium business owners.
Benefits of Inventory Financing
Both inventory loans and lines of credit have less stringent criteria for qualifying than a traditional bank loan. Because businesses can take a while before they have a solid financial reputation, easy approval is an attractive feature.
Those who apply for inventory financing may be able to qualify, even if a bank has denied them. Since the loan is secured with the purchases, an online lender has less risk.
Lenders Take A Holistic Financing Approach
Lenders approve each application on a case-by-case basis. Your business could have a healthy balance sheet with a poor credit rating or vice versa.
Alternative small business financing lenders look at more than the bank account and credit history. Your overall creditworthiness determines the business funding you can obtain.
Another plus is that the application process is typically short and straightforward. Unlike bank loans, lenders might ask about your business assets but won’t require personal assets as collateral.
Before you sign a contract with any lender, read the terms and fine print carefully. If you’re not comfortable with anything you read, move on to the next potential lender.
There are times when you need cash fast, like when your top supplier has a massive sale. It doesn’t make sense to take out a traditional loan and wait weeks to get your money.
If time is of the essence and you need supplies quickly, an inventory loan could be your answer.
You may also like: The Pros and Cons of PO Financing
3. Who Benefits From an Inventory Loan?
The idea of borrowing money has gotten a negative connotation over the past few decades. Yes, there are loan sharks out there ready to con you into horrible terms, but there are also lots of legitimate lenders.
If you’re stuck between losing out on inventory and business or borrowing funds to help — don’t listen to the myths. An inventory loan or line of credit could be exactly what you need.
Examples of Good Uses of Inventory Financing
Suppose there’s a deal that’s almost too good to be true, and you want to capitalize on it with some strategic inventory purchases. You don’t have the cash flow to make it happen, though.
You have the chance to expand your company. Yet, again, there’s no working capital buffer in your budget.
Why miss out on these golden opportunities?
Here are some ideal situations in which inventory financing is a smart choice.
You’re a small business owner who just received an order from a potentially huge client. You don’t have the inventory to fill the request but don’t want to lose the customer.
An inventory loan saves the day, and the client is happy. They remain loyal to you and refer you to others in their network.
You own a seasonal business, and you’re coming out of the slow season.
You want to stock up for the busy time around the corner, yet, you’re low on cash. An inventory loan gives you the cash you need to invest in product.
The busy season hits, and customer demand is high. You make enough in sales to pay off the loan and bring in a profit.
Whether you’re a wholesale retailer, trying to increase product capacity, or need fresh inventory, this type of financing could get you back on firm footing.
4. Borrower Beware: The Cautions of an Inventory Loan
Although you fit the criteria of a perfect candidate for inventory financing, there are some things to watch for.
Tread slowly as you make this decision.
It is a debt that you’ll have to repay. Be sure that you can handle the extra expense.
This can be a struggle for new businesses. What was supposed to help you may end up sinking your financial history if you can’t pay it back.
Other Reasons to Think Twice About an Inventory Loan
You’ve decided you can handle a reasonable monthly expense, especially since it’s supposed to be short-term.
Don’t sign the agreement quite yet!
First, read the terms of the loan.
Fees and interest rates with inventory financing can be higher than other alternative avenues. You might still be able to borrow money elsewhere and get better terms.
One more thing to be aware of with this kind of lending is there are limits to how you can use the funds — it’s not working capital.
The inventory you purchase with the loan is collateral.
At any point, should you default in the terms, it can be taken from your business.
5. Other Financial Alternatives to Inventory Loans
Maybe you’re on the fence about an inventory loan after learning all the pros and cons.
It’s true that inventory loans aren’t for every business.
However, you still may have options.
Alternative Lending Solutions for Business Owners
Your business is unique, but your financial struggles are likely something that other owners have dealt with. Chances are, there’s a solution that matches your needs perfectly.
What you think is holding you back from a loan could be the reason why you qualify for one of these lending options.
Do you have a lot of customers that pay through invoices?
If so, invoice financing is something that solves your problems without the hassle of a loan.
The accelerated invoicing alternative gives you cash now for the money you’ve already earned. Instead of waiting for clients to pay, which can take anywhere from 30 to 90 days on average, sign up for a NowAccount.
- You choose the invoices you want to sell.
- Now pays you the face value of the invoice, minus their fee.
- Now collects the total amount from the client directly.
There isn’t any fine print to worry about or hefty loans to repay. No muss, no fuss; just the cash you’ve already earned in your hands quickly.
Small Business Loans
The Small Business Administration (SBA) is a government agency that helps small businesses connect with lenders. If you can qualify for a small business loan with the SBA, it’s a fabulous opportunity. The requirements are strict, though.
You’ll need to have your tax returns, a profit and loss statement, and many other accounting forms before starting the application. Depending on the loan amount, you’ll also need to meet a minimum annual revenue.
The agency presets the guidelines for each loan. Lenders who are willing to agree to the guidelines become partners with the SBA.
Because the qualifications are stricter, your creditworthiness as a borrower has already been determined. Those lending the funds have less risk. Upon approval, businesses matched with a lender get access to their funds quickly.
Working Capital Loans
Inventory is helpful, but what about the type of business that needs to cover other expenses?
When your income is less than your overhead, a working capital loan can help.
You can use a working capital loan to fund anything that qualifies as a business expense. It’s a short-term solution for an occasional gap in cash flow.
You’ll typically get the funds you need within two business days. As with an inventory type of loan, though, the repayment schedule may require you to pay the full amount back within one year.
Learn more: How Does a Working Capital Loan Work?
There are lots of business loan options available to you if your company meets the criteria. Each of them has its advantages, as well as its downsides.
Deciding on a few factors will narrow down the best financial solution for your business.
- Will inventory financing work for all your needs?
- How detailed do you want to get with a loan application?
- Are you willing to make a personal guarantee to the lender?
These answers and more will help you decide on the kind of financing options to look into next. An inventory loan could be the answer, but it’s definitely not your only choice!
Find out today if you qualify for accelerated invoice payments by creating your NowAccount!