As with other funding options, inventory financing has advantages and disadvantages. Let’s break them down.
Pros of Inventory Financing
It’s always a good idea to weigh the advantages and disadvantages of any business decision. Here are a few of the positives of using inventory financing.
Helpful for Seasonal Businesses
If you want to buy inventory for a seasonal retail store, you may not have the cash flow upfront to get what you need.
For example, a garden center will make most of its money in the spring and summer months, when people are looking to beautify their outdoor spaces. This means they need to have inventory on hand to meet the demand, but they may not have made enough money during the slow months to purchase sufficient stock.
That’s where inventory business loans come in: You can supplement your own working capital to buy the inventory you need to satisfy customer demand.
Renewable Funding Source
A business line of credit is a versatile funding solution for businesses with ongoing working capital needs. When used as inventory financing, it can be a renewable source of income for a growing retail operation.
Since you can withdraw more funding after paying off what you borrow from inventory financing lenders, it’s an appealing solution for retail businesses that need flexible and continued access to capital.
No Risk to Personal Assets
While it’s possible to get unsecured business loans to buy inventory, many lenders need some type of collateral to approve a loan. This often means a business owner’s personal money, vehicles or house can be at risk in the case of default.
Since inventory business loans use the products themselves as collateral, you won’t have to worry about losing any personal assets as with other options (unless you’ve signed a personal guarantee).
Less Emphasis on Credit Score
Lenders often check personal and business credit scores when reviewing financing applications. However, because products secure inventory business loans, your credit score won’t be as much of a factor to lenders.
Your ability to repay the inventory loan directly correlates to how well you can sell the product, so that’s the main focus. While it isn’t easy to secure a loan with poor credit, you won’t need a high credit score just to be considered (e.g., 700+ credit). In some cases it might even be possible to get inventory financing without a credit check.
Cons of Inventory Financing
Although the advantages are attractive, there are a few reasons why inventory financing isn’t the best option for some businesses.
Lenders mitigate their risk by increasing interest rates on business inventory loans. These higher rates can make this type of financing more costly. While inventory loan rates can be lower than 10%, rates can also range up to nearly 100%, depending on the lender.
Note: Your product line has a lot to do with the inventory loan rates for which you can qualify. If the inventory won’t hold value or is difficult to liquidate, rates can be steep.
Lenders always want to minimize their risk, so you’re likely to receive a short term on your inventory loan. Products will be liquidated in the case of default, so offering term lengths between 6-12 months means lenders are less likely to be stuck with outdated items they can’t sell.
While shorter terms can be a boon for those who don’t want to lock up their capital long term, it also raises payment amounts.
Stricter Approval Standards
Inventory financing lenders are unlikely to offer you funding if they don’t think the product will sell based on your industry, sales or demand. The need for lenders to minimize risk also leads to restrictions on uses for small business inventory loans. Products that will quickly become outdated or difficult to liquidate are unlikely to qualify.
Some examples include computer equipment, perishable products and some seasonal items unlikely to have future value, such as New Year’s Eve decorations with the current year printed on them.
Longer Business History Preferred
Inventory financing companies like to see businesses with a pattern of being able to sell inventory quickly and with a solid profit margin. You’ll usually need at least a year in business to prove that. If you need funding with less than a year in business or if you’re seeking inventory financing for startups, you’ll have to explore other financing options.