One of the core challenges of running a business is ensuring you have the appropriate level of inventory to meet anticipated demand. While you may have an inventory system that times your seasonal demand cycles down to a science, securing the capital to finance your inventory is an entirely different task. Accessing credit to fund short-term inventory needs can be especially difficult if your business doesn’t have an established credit history.
We’ve explored the different solutions available to small businesses to keep working capital flowing in past blog posts, and the key practice we emphasized is to have a good balance between installment loans for long-term expenses and revolving lines of credit for short-term needs. This week, we’re going to take a closer look at small business capital and how small businesses can set themselves up to meet short-term needs through inventory financing.
What is inventory financing?
Inventory financing is a form of asset-based lending that allows you to use your inventory as collateral for obtaining a revolving line of credit. Engaging in inventory financing typically requires a lien that follows the requirements of the Uniform Commercial Code (UCC). A UCC lien is a security agreement that gives the lender legal recourse to seize the collateral a business offers – in this case, its inventory – in exchange for a loan. In addition, inventory financing typically comes with a variable interest rate, which means it’s based on an index that’s tied to how the overall market is performing. In other words, don’t plan to pay the same interest rate on every bill. While it might seem like a big risk to offer your inventory as collateral, your business can experience several benefits if this type of financing is appropriately leveraged.
How can your business benefit from inventory financing?
Many small to mid-sized retailers find inventory financing to be a viable option, especially if they find it difficult to secure a standard loan due to a lack of capital or credit history. Once you’ve secured inventory financing or a revolving line of credit with your bank or lending partner, you’ll be able to get the capital you need to increase your inventory during busy seasons, such as when you’re planning to account for an upcoming influx of customers during a holiday rush.
Since inventory financing for small businesses is most commonly obtained through utilizing an established revolving line of credit, you’ll also be able to acquire the capital you need to quickly react to shifts in customer demand at short notice. For example, if you bring your wares to an industry trade show and receive several pre-orders from attendees, then you can rest easy knowing your inventory financing arrangement will provide the necessary funds for purchasing supply to meet this sudden demand.
Speaking of supply, having inventory financing in place can be a huge help for maintaining satisfactory partnerships with your suppliers. By having the money you need to pay your suppliers up front, you’ve taken the first step towards building a mutually beneficial relationship with them. If a supplier can count on you to pay your bills on time, then you’ll be able to count on them delivering the quality goods and materials you need in a timely manner.
What should you consider before applying for inventory financing?
First and foremost, you should only use inventory financing for short-term needs, or in other words, any supply expenses you can afford to pay off in less than a year. If you use the capital supplied by inventory financing for long-term expenses, then that line of credit will be tied up when you need it most, such as while you’re ramping up for the holiday season. Make sure you save your inventory financing for short-term needs while seeking out installment loans or other types of financing for longer-term capital needs.
You also need to make sure you fully understand the state of your industry and its market cycles. Doing so will ensure you can properly forecast your supply needs and take in a level of inventory that you know can be sold by your next payment due date. Other things you should take into consideration include potential issues that may damage the value of your products, such as manufacturer mistakes that result in recalls or a new product coming to market that will cause your inventory to become obsolete (a particular problem in the constantly evolving technology industry). You don’t want to end up with inventory that has to be sold at a discount to move units, or worse, wind up having to turn over your inventory to your banking or lending partner as repayment.
The best time to establish a revolving line of credit that you can utilize for inventory financing in place is when you don’t need it. That way, it’s available when you need to quickly bump up your stock. If you think this arrangement will help your inventory system and help you out of any short-term capital jams you’re expecting to run into, then make it a priority to discuss inventory financing during your next visit with your accountant. Inventory financing might be just the tool you’ll need to expand your revenue and keep your business growing.