ComCap Inventory Financing
Inventory financing is a short-term loan or line of credit established using the purchased inventory as collateral. This type of loan is extremely attractive, because the loan and the collateral involve the same physical product. The business does not need to risk other company assets, in order to secure the loan for the inventory. In addition, the interest rates are generally lower than for an unsecured loan.
Purposes of Financing Using Inventory as Collateral
Companies that sell a product generate revenue as a per unit percentage of goods sold. For instance, if they estimate a demand of 10,000 units in a particular month, then they can harvest that potential by purchasing the units and making them available for sale. However, there can be a time lag problem. Companies may not get sales revenue from the purchased units before the supplier bill is due. This leaves an expense of 10,000 times the cost per unit, which may exceed the company’s supply of cash. One way to deal with this is to setup a delayed payment agreement with the supplier. This may be a net-90 term, meaning the payment is not due until 90 days after delivery. However, not all suppliers will agree to delayed payment plans.
Another method is that companies stock initial inventory with a small business loan, then use the revenue from those sales to finance the next month’s inventory. This continues from month to month. However, not all businesses qualify for an initial inventory loan. In addition, they may not generate enough profit margin to justify the debt for the inventory. Further, seasonal businesses may not be able to generate the steady revenue stream necessary to maintain inventory.
With these limitations, businesses often only acquire only a portion of the number of units they could have sold, and miss a part of the opportunity. This is when companies can take advantage of financing using the inventory as collateral, and acquire the necessary inventory to harvest the full opportunity.
Limitations of Inventory Financing
Inventory is not necessarily strong collateral. When distributors cannot dispose of products, then lending institutions may find it even harder to liquidate the collateral. Lenders have come to realize that if a company could not move the inventory with an established sales channel, then the lender would be even less likely to do so. In addition, some inventory is perishable, and other inventory is only saleable during particular times of the year (i.e. Christmas ornaments.) For this reason, inventory financing is more difficult to obtain since the credit crisis of 2008.
Companies that need inventory can secure inventory financing using the inventory as collateral. This type of loan is only limited by the quality of the collateral.