Table of Contents
** Minutes
How does inventory financing work?
Why companies need inventory financing
2 traditional options for inventory financing
4 other ways companies get capital to purchase inventory
What you need when applying for traditional financing
For product companies there are a few large cost centres that affect the trajectory of the business: Shipping and logistics, marketing, and inventory. By leveraging ecommerce financing options, companies can unlock the shackles of the cost centres and increase potential growth.
Below we will dive into the financing options associated with acquiring inventory.
What is inventory financing?
In short, inventory financing is when you obtain financing for inventory. If this sounds simple, you’re right — but the devil is in the details. Another related option to consider is supply chain financing, which helps optimise cash flow by extending payment terms with suppliers while still allowing them to get paid promptly. This type of financing can be particularly useful for businesses looking to maintain a steady inventory flow without straining their working capital
In theory, you could get any type of financing and spend it on inventory, but some financing options are built specifically for inventory.
Like a mortgage that uses a home as collateral for the loan, certain inventory financing solutions use the inventory as collateral. This gives the lender comfort that in a worst-case scenario where the company defaults on the loan they will have access to something that enables them to get paid back.
How does inventory financing work?
Inventory financing is the same as any other loan in its basic structure. Here are a few steps you should take:
1. Research loans
You want to look for loans that meet your criteria: financing amount, payback structure, company requirements (age, profitability, etc.), and price.
2. Apply for the loan
This can be specific to the lender, but the application process revolves around data. More traditional lenders will have a more cumbersome process while modern lenders will utilise technology to make this process more streamlined.
3. Get funds for inventory
Most lenders will forward the cash directly to your bank account, but some inventory financers can pay your manufacturer directly (if you are financing inventory that isn’t yet in stock).
4. Pay back the loan
This is based on the specific loan agreement, but a few common payback mechanisms include: a fixed dollar amount per month or week, a variable amount based on your sales, or completely variable where the debtor (you) controls exactly how much is paid back and at what time.
Why companies need inventory financing
Companies generally use financing for inventory purposes due to a few core reasons.
1. The need to buy more inventory
Many companies experience out-of-stock situations since the demand for their product outstripped what they could afford. Inventory financing allows companies to put in larger orders to their manufacturers so they have enough inventory to eliminate out-of-stock issues when they arise.
2. They need to unlock capital tied up in inventory.
This is for companies who are able to put in a large enough order so they won’t go out of stock, but need to use some of the capital locked up in their current inventory to use in other areas:
- Increasing marketing spend
- During seasonal periods when sales jump up (and more inventory is required but companies also need to expand their marketing budget)
- Investing in R&D
- Investing in new product lines to stay relevant
2 traditional options for inventory financing
There are two traditional options specific for inventory financing. Mostly from banks, these loans can take different forms which we’ll investigate below, along with their pros and cons.
WIP finance
Work-in-process (WIP) financing in when a lender will finance the manufacturing process, often paying your sub-suppliers for components directly.
Pros:
- It’s very useful if you have long leads times and complicated product architecture.
Cons:
- You don’t always finance the inventory after it becomes finished goods inventory (i.e., you need to pay the loan back before you sell the inventory).
- There is often a lot of operational headaches since the lender needs to keep close tabs on the collateral at the manufacturer.
PO financing
Once a purchase order (PO) is received (normally from a large retailer), the lender will give you money in order to get the PO fulfilled.
Pros:
- A great option if you have a lot of large POs from credit-worthy clients (think nationwide retailers).
- You often don’t have to pay it back until the company creating the PO actually pays their invoice.
Cons:
- You need to have a PO to leverage this type of financing, which isn’t possible for modern direct-to-consumer ecommerce businesses.
4 other ways companies get capital to purchase inventory
Here are some other lending options businesses have traditionally used to purchase inventory that don’t involve using inventory as collateral:
Personal loans
Personal loans are based on your individual credit score (rather than business data) and generally take the form of a “line of credit” or “term” loan.
Pros:
- Can be obtained more quickly than business loans
Cons:
- Generally smaller amounts of cash
- There’s a risk as it can affect your personal credit score
Equity
Equity refers to raising capital and giving up a percentage of the business in return. This is common amongst high-growth companies.
Pros:
- Can generally raise a large sum of capital
- Doesn’t have to be paid back like a loan
Cons:
- Extremely expensive (since you are giving up a percentage of ownership in your business).
- Can take a long time to close funding
AR (invoice) factoring
When you have outstanding invoices (e.g., to a large retailer), you can sell them to an AR factorer. This essentially means you get your invoice paid early for a fee. The factor gets paid from the AR payer.
Pros:
- Can leverage the credit of your AR payer for pricing
Cons:
- Not available if you don’t have AR (which often means direct-to-consumer e-commerce companies)
- Can only obtain financing after the AR is created (often after payment for inventory is due)
Business loans
This includes a wide variety of options available including term loans and lines of credit.
Pros:
- Doesn’t affect your personal credit score
- Can get larger dollar amounts for financing
Cons:
- Can be slow to close financing
- Generally only for loans $300,000 or more
- Many require a lot of paperwork
- Payback isn’t always aligned with your cash flow
What you need when applying for traditional financing
When obtaining traditional financing it can be a burden to produce the required documents, including:
- Balance sheets
- Sales forecasts for 2+ years (or however long the loan is for)
- Tax returns for 2+ years
- Inventory lists (this may need to be updated monthly)
- Profit/loss statements for 2+ years
Alternatives to traditional options for inventory financing
At this point you may be thinking, “I like the sound of the benefits associated with inventory financing (larger inventory orders, more cash for marketing and R&D), but don’t like the sound of all the burdensome aspects associated with traditional loans used for inventory financing (preparing documents, repayment not aligned with cash flow, only available to companies with large retail clients). Are there some other options available that don’t have the same downsides?”
Over the past few years, there have been a few technology-first solutions that may be a good fit.
Kickpay
Built specifically for ecommerce sellers, Kickpay unlocks the capital you have tied up in inventory, or pays your manufacturer directly for new inventory, and only gets paid back when goods ship to your customers.
Pros
- No documentation needed
- No impact to personal credit score
- Only pay back loan when inventory is shipped to customer
- Can qualify with only 3 months of sales history
Cons
- Can’t finance work in progress inventory
- Not good for self-fulfillers (you need to use a third-party fulfilment centre like ShipBob to qualify)
Inventory crowdfunding
A great way to leverage the community to finance work-in-progress inventory.
Pros:
- Can finance work in progress
- Faster qualification than traditional loans
- No impact to personal credit score
Cons
- Can’t unlock value tied to inventory already in stock
- Payback may not be tied to cash flow
Merchant cash advance
Make an estimate on how much revenue your business will make over the next 3-6 months and forward cash to you. Get paid back a certain percentage of sales on a fixed schedule (daily or weekly).
Pros
- No impact to personal credit score
- No documentation needed
- Only pay back when company makes a sale
Cons
- Generally offer smaller financing amounts, especially if your business has multiple sales channels
Conclusion
Aiming to finance inventory is a smart thing to do for companies that have a large cost centre associated with inventory, especially around the seasonal period since it maximises the sales potential of the business by unlocking capital.
Picking the correct financing option is now easier than ever with more modern solutions on the market. In order to pick the best one, you should ask yourself a few key questions:
- When do you need the cash: at the down payment for inventory, on shipment from your manufacturer, or after?
- What do you need to use the cash for: paying for inventory or unlocking capital tied up in inventory you already have for marketing, R&D, etc.?
- When do you want to pay back the financing: in a large lump sum or ongoing in smaller increments?
- How much cash do you need to be impactful for the business?
By answering these questions accurately it will point you towards the most appropriate form of financing.
Store inventory with ShipBob
If you’re in need of a third-party logistics (3PL) company to store your inventory and pack orders as ecommerce customers place them online, get in touch with ShipBob today.