What is inventory financing?
Inventory financing is a form of asset-based funding in which a lender provides you with capital to purchase products to sell. The products you purchase serve as collateral on the financing, so you don’t always have to put up personal or other business assets to secure the loan.
How does inventory financing work?
Inventory financing is a line of credit or term loan that is based on the value of the inventory you want to buy. Although you may ask for a loan amount equal to the total cost of the inventory you’d like to purchase, many lenders will offer you only a percentage of the inventory’s value. This could be as little as 20% or as much as 80% depending on the type of inventory and the lender itself.
Because the value of inventory depreciates over time, offering only a percentage of the loan amount asked for mitigates risk for the lender if you default on the loan and they need to sell off your inventory to recover their losses.
Inventory financing can be a good funding option for:
Purchasing inventory to prepare for your busy season.
Covering short-term cash flow gaps.
Buying additional stock to meet increased customer demand.
Updating product offerings or launching new products.
Types of inventory financing
There are two types of inventory financing: inventory loans and inventory lines of credit. Although the two have separate structures and may be better suited for different purposes, both types are secured by the inventory you’re looking to purchase.
Inventory loans are structured like traditional 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.
Inventory lines of credit
Inventory lines of credit give you access to a set amount of money that you can tap into as needed — and you only pay back what you’ve borrowed. These credit lines are often revolving, meaning once you’ve paid back what you’ve borrowed, you again have access to the maximum approved amount and don’t need to continuously reapply for funding.
Lines of credit offer more flexibility than term loans and work best for financing ongoing inventory purchases.
Pros and cons of inventory financing
Self-collateralizing. You may not need to rely as much on personal credit, time in business or other forms of collateral to qualify for financing.
Good for sales. Inventory financing can be used to meet an increased customer demand, prepare for a busy season or upgrade a product line.
Easy application process. If your inventory records are organized, it can be quick and easy to apply for this type of financing — especially when working with an online lender.
Limited loan amounts. Lenders will typically offer only a percentage of the total cost of the inventory you’re looking to purchase.
Expensive. Interest rates can be higher on this type of financing, especially if you have a lower credit score, less time in business or aren’t using other assets to secure the loan. Although your business still may be able to qualify, the cost of borrowing will be much higher.
Where to get inventory financing
Banks and credit unions
Although banks and credit unions offer some of the most affordable small-business loans, they are less likely to offer inventory financing than other types of business funding because of the riskiness of inventory loans. Many traditional financial institutions do, however, offer SBA loans, which can be used as a form of inventory financing.
SBA loans have long terms and low interest rates, and they allow you to use inventory as collateral. Similar to bank loans, SBA loans require that you have good credit (FICO score of 690+), strong annual revenue and several years in business to qualify.
Online lenders can offer access to inventory financing with more flexible qualifications than SBA loans. Some online lenders will work with new businesses or businesses with bad credit.
Many online lenders have simple application processes, with funding available in as little as 24 hours. However, these loans are typically going to be more expensive than SBA loans, with shorter terms and faster repayment schedules.
Alternatives to inventory financing
For a look beyond inventory loans, check out NerdWallet’s list of best small-business loans for business owners. Our recommendations are based on the market scope and track record of lenders, the needs of business owners, and an analysis of rates and other factors, so you can make the right financing decision.