Every business owner comes across a surprise or two along the way. There’s at least one aspect of running their business that they didn’t expect. For many, it’s the fact that a small business is such an intricate balancing act.
Maintaining the cash flow of your e-commerce business can be a massive challenge. This is especially true if you’re trying your hand in a new industry.
If you’re struggling to maintain the balance of expenses and income, one option you should consider is inventory financing. This guide will fill you in on the basics you need to know first.
What is Inventory Financing?
Some people assume “inventory financing” refers to financing that allows you to buy more inventory. In reality, it’s the opposite. With inventory financing, you’re getting a loan that uses your inventory as the collateral.
Each situation is unique, but lenders will often finance up to 80% of the value they place on your inventory. Note that we said “the value they place” rather than “the market value,” and we’ll go into that in more depth later.
In some cases, inventory financing is a separate loan on its own. In other cases, it’s part of a larger asset-based loan. It all depends on what your business needs and what assets you have available.
Determining if Inventory Financing is Right for You
Speaking of your business’ needs, how do you know if inventory financing is the right way to get the cash infusion you need? These tips can help.
1. Determining How Much You Need
Before you seek any type of financing, it’s important to know how much you need in order to help your business. You need to have a specific use for the money in mind.
Inventory financing only tends to be helpful for businesses who need or want a significant amount of money. Many financial experts recommend avoiding inventory financing if you need less than $500,000.
This is the case because of the significant initial costs and maintenance costs involved. A lender who’s taking on inventory financing will have extensive due diligence before they approve the loan, and that can be expensive. If you won’t get enough from the loan to account for those costs, it’s not worth the expense.
2. Examining Other Options
Inventory financing isn’t a bad or unwise way to get financing, but it shouldn’t be your first choice. As we mentioned, it’s more expensive than many other options.
Before you hop onto the inventory financing train, take a look at other options as well. For instance, depending on your business’ situation, you may want to do supplier financing or to finance your receivables.
As a general rule, it’s smart to lay out all your options any time you’re looking for business financing in the first place.
3. Review Your Potential Collateral
Before you seek inventory financing, it’s important to have an idea of how much financing you’ll be able to get. If it won’t give you enough to meet your needs, it isn’t worth going through the process.
It’s important to recognize that lenders don’t base inventory financing on the market value of your inventory. Instead, there are a few other valuation models they use.
Lenders for inventory financing tend to use either Net Orderly Liquidation Value (OLV) or Forced Sale Liquidation Value (FLV). Most will lend you no more than 80% of this value.
Before you pursue inventory financing, evaluate your inventory’s value based on these valuation models. This will tell you if it’s worth the cost to pursue inventory financing. During the financing process, it can also help you know if the lender’s valuation is fair.
Other Inventory Financing Facts and Tips to Keep in Mind
If you take those steps and determine that inventory financing is the way to go, use these tips and facts to guide your process.
4. Consider Maintenance Costs
As we mentioned, inventory financing tends to have an expensive initial process. However, some businesses overlook the maintenance costs as well.
To maintain an inventory financing line, most lenders will require an inspection every few months. That maintenance cost can be more than some businesses bargain for, so make sure you plan for this.
5. Look For a Specialized Lender
Chances are that your first foray into inventory financing will be a learning process for you. You don’t want it to be a learning process for your lender too.
Look for a lender with experience in inventory financing and in lines of credit for retailers. If possible, get recommendations from other business owners who have used this type of financing.
6. Compare Rates and More
Your inventory financing is a big decision for your business, so you can’t take it lightly. Take your time and shop around for business lenders.
The obvious way to compare lenders is by checking their interest rates. Don’t stop there, though. One lender might have a slightly lower rate but have clauses in their fine print that make it a much larger risk for you.
Be sure to account for the less analytical factors too. How easy is the lender to do business with? Is there someone available to talk to if and when you have questions? Do they have a reliable and convenient way to remit payments?
7. Do a Reputation Check
Few people today would go on a date without doing a little background research into the person, so why would you choose a lender without doing the same?
As you’re comparing lenders, look up each one with the Better Business Bureau. Pay attention to their overall grade as well as the details of any complaints they may have.
On top of the BBB, check out customer reviews online. Chances are that you can find reviews on Google or on banking websites where customers talk about their experiences.
8. Ask About Minimums and Maximums
Many lenders have minimum amounts and maximum amounts they’ll provide for inventory financing. An easy way to narrow your list of potential lenders is to see if the amount you need will fit into their financing range.
Enhancing Your Business with Inventory Financing
Inventory financing can be a great way to get the liquid capital your business needs, but only if you use it the right way. The tips above can help you get through the process and make the right choices along the way.
For more tips about various aspects of running your business, check out our business resources blog.