How Does Inventory Financing Work?

Inventory financing is a type of asset based lending that allows your company to leverage existing inventory. It can provide your company with funds to purchase additional inventory or handle corporate expenses. From this article, you will learn:

  • How inventory financing works
  • What type of due diligence is required to set up a line
  • Advantages and disadvantages of this solution
  • Alternate solutions

How does inventory financing work?

Most finance companies structure inventory financing lines to allow you to get a facility that operates like a line of credit that is backed by your inventory. The facility enables you to draw funds from your inventory as it is acquired from suppliers. The facility is settled when inventory is turned to product and is sold off to customers.

Inventory lines are usually offered with invoice factoring lines. Alternatively, they can be offered as part of an asset based lending program. This approach has the benefit of providing additional financing and is also used for settlement purposes. Basically, once inventory is sold off to a customer, you can finance the invoice and use the proceeds to close the inventory line. At that point, the transaction proceeds as a conventional factoring or receivables-based financing program.

The line can finance up to 80% of the forced liquidation value (FLV) or net orderly liquidation value (NOLV) (this value varies) of your inventory. The actual values used depend on your individual circumstances. Keep in mind that the FLV or NOLV of your inventory can be substantially lower than its current market price.

How does the due diligence process work?

Setting up an inventory finance line requires extensive due diligence. The lender first examines your financial statements to determine if your company qualifies for this solution. If your company does qualify, the lender schedules a field examination to review your company and appraise the inventory. This process can take a couple of weeks.

As part of the due diligence process, the examiner reviews your inventory tracking and management system. This last point is a key component of the due diligence. Inventory finance companies require that clients use a perpetual inventory system.

As you can imagine, the due diligence for this solution can be costly due to the travel expenses to the client’s facility and the use of outside experts. Consider budgeting $10,000 to $15,000 to cover these expenses. Note that the actual expense is determined by the complexity of the assets and your company.

What are the advantages?

The primary advantage of an inventory financing line is that it can provide funding if you are unable to get a bank line of credit. Furthermore, the line can increase as your business grows. This flexibility can be very useful for companies that are expanding. Lastly, an inventory financing line allows you to leverage your finished product and work-in-progress inventory. Few other products can do this.

What are the disadvantages?

However, inventory financing lines do have some disadvantages. The most important disadvantage is the due diligence and maintenance costs. Due to the nature of inventory, lenders usually require that clients go through a field examination regularly – as often as quarterly but at least once a year.

Another disadvantage is that the forced liquidation value, or, if used, the net orderly liquidation value, can be dramatically lower than market value. Given that the advance is based on these values, the actual amount of leverage can be small.

Alternate solutions

Because of the cost disadvantages, inventory financing should not be seen as a first choice for financing. Instead, consider it as an additional source of funding if other, less expensive sources do not provide enough money. Your first option should be invoice factoring, which is relatively easy to secure and is quick to set up. Alternatively, you can use an asset based loan that finances your invoices. If those solutions do not provide sufficient funds, then consider adding the inventory line.

Additionally, if you are re-selling finished goods, consider using purchase order (PO) financing instead of inventory financing. This solution allows you to finance supplier expenses associated with specific customer purchase orders. Purchase order financing is cheaper and easier to set up than inventory financing. However, you can use PO financing only if you re-sell goods, with minimal – if any – modifications, that were purchased from a supplier.

Need an inventory financing quote?

We are a leading inventory finance company and can provide you with a competitive factoring, inventory financing, asset based lending, or purchase order financing quote. For more information, fill out this form or call us toll-free at (877) 300 3258.