One of the toughest aspects of owning a small business can be financing. While many small businesses get financed using money from investors, bank loans and credit cards, each of these can negatively impact your credit score. Additionally, if you have a longer sales cycle, you may encounter cash flow problems and find it difficult to make monthly payments on these types of loans.
One option that might work for you and your revenue model is inventory financing. True to its name, inventory financing allows you to leverage your biggest business investment—your inventory—as collateral against a loan. Some businesses even choose to use this method during times of the year when they need to increase their inventory (e.g. the holidays) as it gives them the extra money and inventory they need to meet demand.
Who Benefits The Most
In general, small to medium-sized retailers find this type of financing the most beneficial. While larger retailers like department stores have no problem borrowing the money they need from large financial institutions, smaller retailers don’t always have that option. If you find it difficult to secure a standard loan from a bank due to lack of capital or financial history, then inventory financing might work for you. Small to medium-sized wholesalers can also benefit from inventory financing.
Pros of Inventory Financing
As with any business decision, especially one involving money, you want to carefully weigh the pros and cons. Here are the top pros for using inventory financing.
- It doesn’t count on your credit report. This is helpful as it will not impact your debt-to-income ratio, which is one of the key figures traditional lending agencies look at.
- Decisions are typically made quickly. The amount of required paperwork is also less than a typical bank loan, and most decisions are made within two weeks.
- This type of financing has low barriers to entry. Loans based on a business’ inventory typically have lower or variable interest rates, low closing costs and no prepayment penalties, making it a fairly low-risk proposition for the borrower.
Cons of Inventory Financing
Inventory financing can have drawbacks too. Here are some of its disadvantages.
- Many agencies consider inventory financing a high-risk investment. Everything from a downturn in sales to stolen inventory can impact the validity of the investment and make it difficult for lenders to take a risk.
- You have to check in with your lender regularly. Unlike a typical loan, where you are responsible for a monthly payment, inventory financiers require borrowers to stay in constant contact, including a monthly check-in that updates the lender on the company’s inventory levels and turnaround time. Some lenders may also require a UCC lien. This is common practice when the borrower pledges collateral to the financier in exchange for a loan.
- Floating interest rates can be variable. Many loans offer fixed interest rates which over time are more attractive to borrowers as they don’t have to worry about market fluctuations increasing what they pay. With a floating interest rate, these market ups and downs can impact inventory financing loans, causing borrowers to pay more in fees. And this money does not get applied to the loan’s balance.
Finding different ways to finance your business can be challenging, but there are a variety of options, even ones outside of normal banking institutions. Make sure when contemplating any type of loan to weigh all of your options, view the ins and outs of each agreement and make sure it’s the right fit for you and your business. Following those steps is the best way to ensure financial success.
Financing is just one part of a business’ financial picture. To help you gain a clearer understanding of your business’ finances, here are seven accounting formulas that every business owner should know.