Guide to Inventory Financing For Businesses

Inventory financing is a type of small-business loan that helps you buy inventory, or products, for your small business and uses the inventory you’re purchasing as collateral on the loan. You can get inventory financing from banks, credit unions and online lenders. Inventory-heavy businesses that are struggling with cash flow are looking to expand or those that want to access discounts by buying products in bulk may benefit from an inventory loan.

What is inventory financing?

Inventory financing is a type of loan used to buy finished goods or raw materials for the products your business sells.

It can be easier to qualify for inventory financing compared to traditional loan options — the inventory purchased acts as collateral, so you might not need to use additional business assets to secure the loan.

You can use inventory financing to:

• Purchase inventory to prepare for your busy season.

• Cover cash flow gaps.

• Update product offerings or launch products.

• Purchase products in bulk at a discount.

How does inventory financing work?

Inventory financing is available from banks, credit unions, and online lenders. The capital provided by a lender depends on the value of the inventory you wish to purchase. While you might request a loan amount that covers the full cost of the inventory you want to buy, many lenders will only grant a percentage of the inventory's value. This percentage typically ranges from 20% to 80%, influenced by the type of inventory, your qualifications, and the lender.

Since the inventory's value depreciates, providing only a percentage of its value reduces the lender's risk if you default on the loan and they must sell your inventory to recoup their losses.

Types of inventory financing

Inventory financing can be structured as term loans or lines of credit. The right option for your business will depend on your specific needs.

Inventory loans function like traditional business term loans, in which you receive a specific amount of capital and pay it back, with interest, over a period of time. Term loans may have higher borrowing amounts and longer repayment periods, making them a better choice for financing large, one-time inventory purchases.

An inventory line of credit provides access to a predetermined amount of funds that you can use as needed, and you only repay the amount you borrow. These business credit lines are typically revolving, so once you repay what you've borrowed, you regain access to the full approved amount without needing to reapply for funding. An inventory line of credit offers greater flexibility compared to a term loan and can be a suitable option for financing ongoing inventory purchases.

Similar to term loans, the speed of funding can differ based on the lender type. However, unlike term loans, lines of credit allow you to make multiple funding requests throughout the loan's duration. This is an important factor to consider when planning to take a draw.

How to get inventory financing

1. Access Your Qualifications

Most lenders will assess your personal credit score, business tenure, and annual revenue when evaluating your loan application. For inventory financing, they will also take into account the value of the inventory you intend to purchase, along with any additional collateral you can provide.

While banks and credit unions generally offer the most competitive rates and terms, you will likely need good credit, strong financials, and several years in business to secure funding. Conversely, online lenders tend to be more flexible with their qualification requirements. These lenders might work with startups or borrowers with poor credit, but they will impose higher interest rates.

2. Compare Your Options

You’ll want to research several inventory financing options to determine which one is the best fit for your business. Consider comparing factors such as:

• Repayment terms. Inventory loans often have short repayment terms and may require frequent (daily or weekly) payments. You should make sure that you can afford to repay any potential debt before taking it on.

• Interest rates and fees. Inventory financing may be more expensive than traditional bank or SBA loans. You’ll want to ensure that you understand what the rates and fees are and how they’re charged. If a lender quotes interest as a factor rate, it’s helpful to calculate it into an annual percentage rate to get a better sense of the loan cost.

• Funding Speed. You may be able to get inventory financing from an online lender within 24 hours of approval. Some of these lenders charge higher rates, however, so consider if speed is worth the additional cost.

3. Organize Documentation and Apply

The business loan application process will vary by lender, but you’ll typically need to provide documentation such as:

• Business bank statements.

• Business tax returns.

• Business financial statements

• Current inventory list.

• Sales records and projections.

After you submit your application and receive approval, you may get access to funds as quickly as the same day — depending on your lender. Before signing the business loan agreement, however, you’ll want to review it to make sure the terms and rates are correct, and you’re clear about any penalties or fees.

Inventory Financing Alternatives

If you’re having trouble finding or qualifying for inventory financing, there are other options to consider:

• Invoice financing or factoring: Both invoice financing and invoice factoring can help B2B businesses cover gaps in cash flow by advancing money on unpaid customer invoices. With invoice financing, your unpaid invoices serve as collateral on a loan until your customer pays you. With factoring, a company purchases your unpaid invoices at a discount, and takes over collecting the money from your customers. 

• Business credit card: Similar to a line of credit, a business credit card is a revolving line that only charges interest on money you have spent on the card. As you pay down the card, you can spend money on it again. 

• Purchase order financing: Similar to inventory financing, purchase order financing is a lump sum of money that can be used to cover cash flow gaps. While inventory financing can be used for general inventory needs, however, PO financing is tied to the needs of a specific purchase order. 

• Equipment financing. If your business is not inventory-heavy, but you want a self-collateralizing loan option, equipment financing allows you to purchase business equipment and use it to secure your loan.