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Inventory finance Guide 2023
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Inventory is cash. Cash that is tied up in objects sitting in stock rooms, show rooms and on factory floors. Objects that can deteriorate over time or become obsolete. Objects that can be lost or stolen. Inventory ties up cash that could otherwise be redeployed into funding business growth and expansion. It makes sense to try and keep inventory levels lean and use the money saved elsewhere. However, insufficient inventory levels will hurt sales and can even alienate customers when you are unable to fulfill orders and demand spikes.
This guide explores the options for best-in-class inventory management and how inventory finance can support cash flows and help you grow your business.
Best Practice Inventory Management
The first step in controlling the cost of inventory is knowing exactly what you own, how long you have owned it for, what it cost you, what it is worth today and where it is located.
The following 5 fundamental steps to best practice inventory management will assist you in this process:
Organise Your Inventory
Most businesses find that in accordance with the 80/20 rule, 20% of inventory produces 80% of profits. Understanding what merchandise makes up the 20% will ensure that you prioritise this inventory over other items and re-stock frequently. Divide the remaining 80% of merchandise into medium-value stock that requires regular re-stocking and low-value stock that should either be cut from the product list of restocked only irregularly.
Your warehouse, stock room and show room also needs to be organised so that all employees can locate items quickly and efficiently. Keeping items and categories clearly labeled also improves warehouse productivity.
- Track Your Inventory
Once you know what inventory you own, track it to understand where it is. This includes following products through the production life-cycle if you are a manufacturing business.Traditionally, bar-code scanning was used to track inventory but we are now seeing an increase in faster methods including radio-frequency identification (RFID) tags.
- Record Inventory Levels
Managers have long used Excel spreadsheets for inventory records despite the limitations they present including the risk of data loss and mistakes. Using cloud-based tools ranging from a Google spreadsheet to purpose-built operating software ensures that data is not lost and can be continually updated by several people in different locations. - Protect Your Inventory
Protect your inventory from theft, deterioration or destruction by having adequate protections in place. This includes security practices such as maintaining locks, passwords, video surveillance or guards. You should also install sprinkler systems and fire alarms including back-to-base alarms. Finally, speak to an insurance broker about whether your commercial insurance plan covers your inventory in the event of damage or loss. - Analyse Your Inventory
Understanding the value of your inventory and how it impacts your returns is essential for efficient management. Establish the key KPIs of your inventory and track them over time. KPIs such as inventory turnover (COGS / average inventory) and the percentage of working capital tied up in inventory can help you establish if you are keeping inventory levels that are excessive relative to your competitors. Statistics on inventory write-downs and write-offs highlight if you need to review product lines and purchasing decisions. Tracking order status and fill rate will allow you to track the efficiency of your warehouse staff.
What is Inventory Finance?
Best practice inventory management strategies can dramatically reduce the amount of cash tied up in inventory. However, if you are selling large or expensive products that only sell infrequently or if the nature of the industry you are in requires you to build inventory ahead of seasonal spikes in demand, you may need to look for other options to fund inventory growth. Inventory finance allows you to access the funding you need to build your stock without putting a strain on cash flows.
Inventory finance is a type of line of credit which is used to purchase stock for your business. When you decide to purchase stock for your business, the lender will pay the manufacturer directly and you repay the lender after an agreed-upon time (typically a couple of months) or when the item sells.
Lenders set a previously agreed-upon loan limit, typically ranging from $100,000 to $3 million or more and you access this credit when you need to purchase new stock. Lenders take security in the form of the stock that you are financing.
Why Use Inventory Finance?
Inventory finance is an excellent option for many companies that operate in challenging environments:
- To Build Inventory
Many companies operate in environments of seasonal demand, from retail stores building stocks ahead of Christmas or a farmer purchasing seeds ahead of planting season. Seasonality requires preparation and expenses often occur long before sales are possible. Inventory finance allows you to finance the purchase of stocks or raw materials ahead of selling your products.
In addition, you may be negotiating a very large order and need to begin producing sufficient merchandise to fulfill the order before all papers are signed. While debtor finance only works with a valid invoice, inventory finance allows you to finance your inventory before the deal is signed. - To Access Working Capital
Vendors of high-value machinery and equipment such as car dealerships utilise inventory finance to purchase stock, thereby allowing them to reinvest their cash flows in the daily operations of their business. - You Lack Other Collateral
Inventory finance allows you to fund your company’s growth without using property as collateral. If you don’t own property or have already borrowed against your property assets, inventory finance may be a great option for your business. - For International Transaction
Inventory finance arrangements can help speed up payments and avoid delays in international trade.
Floorplan and Dealership Finance
In the inventory finance space, there are lenders who lend to companies operating in specific industries and have tailored finance products to suit these companies.
Floorplan finance is an inventory finance product designed specifically for retailers who want to maintain stock levels and fill shelves. Examples of floorplan finance customers ranges from retailers who need help purchasing high-value items to retailers who need to stock shelves ahead of periods of high demand.
Dealership finance is a form of floorplan finance designed specifically for dealerships such as those selling cars, trucks, motorcycles, agriculture equipment or other large machines. The lender extends a line of credit to the dealer specifically to purchase these big-ticket items. The dealer repays the lender when the item is sold. Dealership finance providers often also provide additional services specifically customized for dealerships including flexible repayment terms, payment extensions and inventory management software.
Inventory Finance in International Transactions
Trade finance includes both export finance for businesses selling good abroad and import finance for businesses importing raw materials or goods from abroad. It is used to reduce the risks inherent in international trade such as the risk of paying for products that never arrive, arrive faulty or when a shipment is dramatically delayed. Common trade finance products include debtor finance or letters of credit.
Debtor finance is a form of trade finance in scenarios such as when an importer takes out a loan secured by the final purchase invoice. The lender has confidence that the products will be sold and will be repaid when the buyer pays the invoice.
Inventory finance can be used as a form of trade finance for cross-border transactions when there is no final buyer or invoice to secure the loan against. Normally in this scenario, inventory finance is in the form of a letter of credit extended by the lender to the original seller. The lender will pay the original seller on proof of shipment or proof of receipt. Should you be unable to repay the lender, they will take possession of the stock used to secure the loan.
Read more about trade finance and debtor finance.
Who Qualifies for Inventory Finance?
Inventory finance can be challenging to access. Lenders often carry out extensive due diligence to understand not only your business’s financial history but also your inventory management practices as well as the details of your inventory including its value and marketability. Once an inventory line of credit has been established, the financing functions similarly to how a credit card would work if your credit card only allowed purchases of specific goods.
Lenders typically have the following requirements for inventory finance borrowers:
- Marketable Inventory
To qualify for inventory finance, your business must be product-based, the value of the products sold must be easily estimated and the products should be highly marketable. Examples include IT equipment, cars or raw material commodities. Good candidates for inventory finance include businesses in manufacturing, food, wholesale or retail.Service-based businesses will need to look for different forms of finance as they typically do not hold inventory.
- Several Years of Positive Trading History
Named risk insurance Providers of inventory finance need to review historical sales figures and inventory records to understand how fast your products sell, what your inventory write-off statistics are etc. This means that prospective borrowers often need to show a minimum of two years’ worth of operating history to qualify for inventory loans. - Strong Financial and Inventory Accounting Systems
Lenders typically want to be assured that both the borrower’s financial controls as well as inventory accounting and controls are solid and accurate.
Solid inventory accounting is necessary for lenders to be certain that their collateral exists and is in good condition. To access inventory loans, you must be able to provide basic KPIs about your inventory such as stock turn etc. as some lenders specify minimum levels.
Key Considerations for Inventory Finance
Inventory finance can be extremely helpful in allowing you to build stock ahead of periods of high demand or fund purchases of high-value stock. It can be a great tool to help you grow your business quickly while maintaining strong working capital.
There are however some key traits of inventory finance to consider before committing:
- Inventory Finance is Costly
Inventory loans are a more expensive form of finance compared to for instance debtor finance which is secured by invoices or a line of credit which is often secured by property or bank. When using inventory as collateral, the lender has to factor in the costs and time associated with selling the stock in the event of non-payment which will drive up interest costs.
The borrower also often has to pay for the cost of appraising the stock both at set-up but potentially also on a regular basis. Ensure that you include all costs and fees associated with the loan in addition to the interest paid when calculating your total outlay. - Approval Process is Slow and Time-consuming
The extensive due diligence done before an inventory finance line is approved takes time and will take your attention away from running your business. If you need cash immediately, you may again consider other forms of borrowings. - Loans are Based on the Appraised Value of the Stock
The appraised value of the stock may be lower than the price offered by your supplier. In this case you may not be able to borrow the full amount of financing you were initially hoping for.
Alternatives to Inventory Finance
If you find that inventory finance is not right for your business, you may want to consider these alternative forms of finance to fund growth:
- Unsecured Business Loans
If you do not want to post any collateral at all in the form of property, equipment or stock, you may want to consider unsecured finance. While expensive, unsecured finance can be quick to obtain and the requirements for documentation are much lower than for inventory finance. While the absolute interest rate for unsecured finance can be expensive, if you are using the funds for a short period or the opportunities you are funding provide reasonable margins, then unsecured financing can still be an attractive solution for your business.
Learn more about unsecured business loans. - Secured Business Loans
A secured business loan will be less expensive than inventory finance if your business owns property that you are prepared to post as collateral for the loan. There are no restrictions on uses of a secured loan meaning that you can use it to fund growth, invest in your premises or fund marketing.
Learn more about secured business loans. - Personal Loan for Business
If you are prepared to personally guarantee a loan for your business, a personal loan for business can be a very quick way to access funding.
Learn more about personal loans for business. - Business Line of Credit
A business line of credit is similar to an inventory finance line in that you can access funds as and when you need them. A business line of credit will be less expensive than an inventory loan as the lender takes collateral in the form of property or a bank deposit. You will also have much more flexibility as to the use of funds with a business line of credit.
Learn more about business lines of credit. - Debtor Finance
If you have buyers lined up for your products, debtor or invoice finance is a cheaper form of finance compared to inventory finance. By providing invoices as collateral, lenders have more confidence that they will be able to collect on the loan, and so will lend at lower interest rates.
Learn more about debtor finance.
In Conclusion
If your business is forced to hold substantial and valuable stock in anticipation of demand or seasonal spikes in demand, inventory finance may be an excellent option for your business. Inventory finance avoids tying up substantial cash in inventory, freeing cash flow and allowing you to reinvest that cash in your business.
Should you be interested in learning more about how inventory finance can help your business or want to know more about financing your business in general, contact us for more information.