Inventory financing: How it works and alternatives

Inventory financing gives your business the cash flow it needs to fill orders and grow. While traditional inventory financing works directly with your supplier, you can use almost any business loan or line of credit to cover the cost of new inventory. The best option for your business depends on factors like your industry and how often you’ll need financing.

What is inventory financing?

Inventory financing is any type of financing that a business uses to buy wholesale products to sell. It’s most commonly used by growing small businesses that can’t qualify for a bank loan but need funds to meet demand. It can also be used to improve cash flow. While inventory financing often more expensive than a traditional bank loan, but comes with more lower time in business, credit score and revenue requirements. It’s also faster — some providers can fund a loan within 24 hours.

Pros and cons of inventory financing

Inventory financing has many benefits, but it comes with several drawbacks you should consider before applying.

Pros of inventory financing

One of the main benefits of inventory financing is that it comes with collateral built into the loan. That can make it easier to qualify for than other types of financing. And even unsecured inventory financing options typically come with fewer requirements than your typical lender.

Traditional inventory financing providers can also sometimes send the funds directly to your supplier to speed up the process. And many offer the option to continually finance your inventory expenses if you experience cash flow gaps.

Cons of inventory financing

One of the main drawbacks of inventory financing is that many options often comes with high interest and short loan terms compared to a traditional bank loan. Especially if you go with a provider that doesn’t require collateral and accepts startups or poor credit.

If you go with a lender that uses your inventory as collateral, you might also be required to pay a down payment on your inventory. In some cases you also might need to have your inventory regularly appraised. This is can be time-consuming for some businesses — and difficult to conduct if you operate entirely online.

Inventory financing explained

Traditional inventory financing is a short-term loan or line of credit backed by the inventory that your business is using the funds to purchase. Retailers and wholesalers often use it to stock up for the busy season, introduce new products or cover cash flow gaps during slow periods. Generally, you can only use inventory financing for non-perishable products since the inventory loses its resale value over time.

With inventory financing, the lender treats your inventory as collateral, so how much you can borrow depends on the value of your inventory. The lender often requires a down payment of around 20% and pays your supplier directly instead of sending you the funds. And if you fail to repay the loan, you’ll lose your inventory.

Sometimes, you’re required to work with specific fulfillment centers to qualify for a loan — especially if you have an online business. These providers sometimes collect payments in monthly installments, or a percentage of your sales. You’ll often pay a fixed fee instead of interest, which can result in APRs well over 100%.If you’re only looking to finance the cost of one specific customer purchase order, purchase order financing may be a better fit.

Alternatives to traditional inventory financing

There are other ways to finance inventory without using your inventory as collateral. These include unsecured term loans, lines of credit and cash advances. However, others may use other business assets like property or vehicles as collateral instead of inventory.

• Lines of credit
• Term loans
• Merchant cash advances
• Accounts receivable financing

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Lines of credit

A line of credit allows your business to continually access cash to replenish your inventory as needed. You can typically use your inventory as collateral or apply for an unsecured credit line. But generally, you’ll have to pay the manufacturer yourself, so it requires more work than traditional inventory financing.

Lines of credit tend to be less expensive than inventory financing because they usually come with interest instead of a fixed fee. But credit lines of online lenders are often more expensive, with rates reaching 80% APR or more in some cases.

Term loans

A term loan offers a one-time lump sum of financing, which you repay plus interest. It’s a good choice for businesses that don’t regularly need inventory financing. Like a line of credit, you can use the inventory as collateral or apply for an unsecured term loan. And also, like a line of credit, you’ll have to pay your suppliers yourself — so it may take more time to receive your inventory.

Related: Best business loans

Merchant Cash Advances

Merchant cash advances give an advance on future sales for businesses that serve customers, like retailers. You can usually get a percentage of your average monthly sales upfront, which you repay with a percentage of your daily sales — plus a fixed fee. These typically don’t come with credit or time in business requirements.

But merchant cash advances are one of the most expensive types of business financing. APRs regularly reach 300%, and the daily payments can be inflexible. Save this option as a last resort.

Accounts receivable financing

Accounts receivable financing, also known as invoice factoring, involves selling your business’s unpaid invoices to a factoring company at a discount. It’s generally best for businesses that work with other businesses, like wholesalers.

You can typically receive around 85% to 90% of the value of your unpaid invoices upfront. The factoring company gives you the remaining amount, minus the fee it charges, after your clients pay the invoices.

Your eligibility doesn’t rely on your personal or business financial history, making it a good option for startups and business owners with bad credit. But like many options for these types of borrowers, APRs are higher than your average term loan or line of credit.

How inventory financing differs from accounts receivable financing

The main difference between inventory and accounts receivable financing is that inventory financing can fund future projects, while accounts receivable financing finances projects you’ve already completed. You can use the funds from accounts receivable financing to pay for any business expense, including buying more inventory. But inventory financing is only available for purchasing inventory.

The financing structures are different as well. Inventory financing involves taking out a loan backed by your inventory, which your business repays with installments. Accounts receivable financing involves selling your business’s unpaid invoices to another company. Factoring companies typically collect on the unpaid invoices from your clients or ask you to pay down the advance as your clients fill their invoices.

Both are considered high-risk financing and can be expensive. But the risks to the lender are not the same. With inventory financing, your collateral may lose value over time. With accounts receivable financing, there’s a chance your clients won’t pay their bills. Inventory financing is also available to retailers and wholesalers, while accounts receivable financing is only available to wholesalers.

Inventory financing for startups

Inventory is one of the first things you’ll need to purchase if you’re starting a new company. But you typically can’t qualify for inventory financing without a record of at least a few months of sales.

If you need seed money to buy inventory, microloans might be your best option. Typically microlenders offer up to $50,000 in financing and have programs that are designed to help get startups off the ground.

How the economy may affect your chances of getting inventory financing

Whether you sell household goods or fashion accessories, lenders assess the value of your inventory when making a financing decision. They look at factors like resale value, depreciation, and likelihood of theft — as well as the state of the overall economy — in determining your eligibility.

When the economy is in a recession, products that aren’t staples may not sell — making inventory financing risky for lenders. If your business sells products that the average consumer isn’t likely to buy when their budgets shrink — like they did during the global financial crisis of 2008 — you may have difficulty securing inventory financing, if at all.

Read our guide to business lines of credit to learn more about this option and if it’s right for your financing needs.