Inventory Financing: How It Works & When To Use It

Having a product go viral presents an exciting opportunity, provided you can fulfill orders and maintain adequate inventory. As more and more orders pour in, you may find your cash flow isn’t sufficient to keep in-demand inventory stocked.

That’s where inventory financing steps in to save the day. With inventory financing, you can get the capital you need to stock up on products, which serves as collateral for the loan.

Read on to learn how inventory financing works and how to secure financing to keep your business bustling.

What is inventory financing?

Inventory financing is a loan or line of credit small business owners use specifically to buy inventory—either finished goods or raw materials to manufacture products. It’s useful for businesses selling or manufacturing physical goods, including retailers with physical stores, ecommerce retailers, manufacturers, distributors, and wholesalers.

Inventory financing is a secured loan, meaning the products or materials you purchase will serve as collateral. If you can’t make payments, the lender can seize your products for compensation. Most lenders limit how you can use the loan, and how much you can borrow, often a percentage of the total cost of the goods you want to purchase. You can’t, for example, take out an inventory financing loan and decide to use it for payroll.

In order for inventory to work as collateral, it has to be nonperishable and able to hold its value for the length of your loan terms. That means you can’t use inventory financing to purchase products like flour for your bakery, but you can use it to purchase spatulas you sell in your kitchen supply store.

Common uses for inventory financing

Here are common reasons small businesses use this type of business financing:

• Cash gaps. Many businesses use inventory financing to cover short-term cash gaps. If your cash is tied up in other business expenses, inventory financing can help maintain stock without disrupting daily operations.

• Product launches. After putting resources into product development, you might need additional funds to get your product made. Financing can help you manufacture and stock your inventory line for launch.

• Seasonal demand. Businesses can also use inventory financing to prepare for spikes in seasonal customer demand.

• Bulk discounts. Both established and new businesses can use inventory financing to save money by buying products in bulk. Calculate whether a wholesaler’s bulk purchase discount outweighs the total cost to secure financing.

How does inventory financing work?

Inventory financing can be in the form of a business line of credit or loan. Both options require you to work with a lender, typically a bank, credit union, or online lender.

With a term loan, you apply for a loan in the amount you need to buy inventory. If the lender approves your loan, they’ll give you a lump sum with fixed repayment terms, including interest.

For a line of credit, the lender approves a loan up to a specific amount you can draw on as often as you need during the draw period. You pay interest only on the money you draw, not the amount you are approved for. Often, a line of credit is revolving, meaning once you repay the money you’ve borrowed, you get access to the full credit line again. This means you won’t have fixed payments—they can go up or down depending on how much you’ve spent.

How to secure inventory financing

1. Assess your financing needs
2. Compile documentation
3. Get preapproval from lenders
4. Compare your options
5. Apply

The application process for an inventory financing will be familiar if you’ve ever borrowed to buy a home or taken out an SBA loan. Lenders require you to provide a lot of information before they hand over cash, so get your paperwork in order before you apply.

1. Assess your financing needs

Before you take out a loan, you need to know how much money you need to buy inventory. To do that, compile a list of all the expenses associated with purchasing inventory, as well as your projected sales volume and forecasted demand.

For example, imagine you want to hold six months of stock. You estimate you’ll sell 1,000 t-shirts a month, so you need to order 6,000 t-shirts. If each shirt costs $3, you’d need $18,000 in inventory financing.

Get a few itemized estimates from your suppliers so you know what you’ll be spending. This estimate can also come in handy to prove the value of the inventory to the lender, so have the value of the collateral available if you default on your loan.

2. Compile documentation

The lender will want proof of your business income. Gather all the necessary documentation to give to the lender ahead of time, so you’re not scrambling at the last minute, including:

• Business financial statements, like a cash flow statement or profit and loss statement, show how much you’ve earned in sales and your typical expenses

• Personal and business tax returns

• Personal and business bank statements

• A list of your current inventory

• Sales forecasts

3. Get preapproval from lenders

Research at least three different lenders to compare their offerings and ensure you get the best terms. Then, fill out a preapproval form for each to see the exact loan terms they’ll offer.

Preapproval is less in-depth than a full application. The lender will likely check your personal credit report and may ask about your basic business finances. They won’t require all of your documentation until you actually apply.

4. Compare your options

If a lender pre-approves you, they’ll give you a document sharing the details of the proposed loan. As long as the information you provided in the preapproval step is accurate, terms shouldn’t change when you submit a final application.

Always read the fine print of all loan documentation. Here’s what to look for:

• Interest rate. Interest rates for inventory financing can be higher than SBA loans. Online lenders often have higher interest rates than banks or credit unions, but accept lower credit scores and short (or no) business history.

• Repayment terms. Make sure the loan terms are feasible for your business, and check for any prepayment penalties. Some inventory financing loans require daily, weekly, or monthly payments.

• Funding speed. Some lenders act fast, providing cash within one business day. Others may take a couple of weeks before releasing funds. If you need the funding quickly, make sure the higher interest rate that often comes with faster funding is worth the cost.

• Requirements for additional collateral. Sometimes, the potential resale value of the inventory you want to purchase won’t be enough to satisfy the lender. They may want to see what other collateral you can offer in the form of business assets.

• Loan minimums and maximums. Some lenders have maximum loan amounts, so make sure you’re not asking for too much. Additionally, some require you to take out a minimum amount, so make sure you’re comfortable with that as well.

5. Apply

Once you’ve determined the loan that’s the best fit for your business, it’s time to apply. Submit all required documentation. If you’re applying online, the lender likely has a portal where you can upload your application and documentation. If you’re applying in person, your loan officer will collect the paperwork.

Approval times vary depending on the lender. But you should expect to hear back within a few weeks at the latest.

*Shopify Capital loans must be paid in full within a maximum of 18 months, and two minimum payments apply within the first two six-month periods. The actual duration may be less than 18 months based on sales.