Financing Basics: What IS INVENTORY FINANCING AND HOW TO USE IT

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For companies that make and sell physical products there are a few key expenses that affect the trajectory of the business. These include shipping and logistics, marketing, and inventory. The largest of these cost centers is frequently inventory. Often 30% of a company’s revenue is dedicated to inventory.

Inventory financing is a way that companies can unlock this capital, enabling accelerated growth. 

Below we will dive into:

  • The basics of inventory financing.
  • Why companies need it.
  • Traditional financing options.
  • Modern financing alternatives.

What is inventory financing?

Inventory financing is an asset-backed loan made to a company so it can purchase products for sale. If this sounds simple, you’re right — but the devil is in the details.

In theory, you could get any type of financing and spend it on inventory, but some financing options are built specifically for inventory.

Like a mortgage that uses a home as collateral for the loan, certain inventory financing solutions use the inventory as collateral. This gives the lender comfort that in a worst-case scenario, where the company defaults on the loan, they will have access to something that enables them to get paid back.

Why do companies need inventory financing?

Companies generally use inventory financing due to two core reasons: 

1. They need to buy more inventory.

Many companies experience out-of-stock situations since the demand for their product outstripped what they could afford. Inventory financing allows companies to put in larger orders to their manufacturers so they have enough inventory to eliminate out-of-stock issues when they arise. 

2. They need to unlock capital tied up in inventory.

This is for companies who are able to put in a large enough order so they won’t go out of stock, but need to use some of the capital locked up in their current inventory to use in other areas. These include:

  • Increasing marketing spend.
  • Meeting demand during seasonal periods when sales jump up (and more inventory is required but companies also need to expand their marketing budget).
  • Investing in R&D.
  • Investing in new product lines to stay relevant.

Traditional options for inventory financing

There are two traditional options specific to inventory financing. Mostly from banks, these loans can take different forms which we’ll investigate below, along with their pros and cons. 

WIP financing

Work-in-progress (WIP) financing is when a lender will finance the manufacturing process, often paying your sub-suppliers for components directly. 

Pros: 

  • It’s very useful if you have long leads times and complicated product architecture.

Cons:

  • You don’t always finance the inventory after the products are finished goods (i.e., you need to pay the loan back before you sell the inventory).
  • There are often a lot of operational headaches since the lender needs to keep close tabs on the collateral at the manufacturer.

PO financing

Once a purchase order (PO) is received (normally from a large retailer), the lender will give you money in order to get the PO fulfilled.

Pros:

  • A great option if you have a lot of large POs from credit-worthy clients (think nationwide retailers).
  • You often don’t have to pay it back until the company creating the PO actually pays their invoice.

Cons:

  • You need to have a PO to leverage this type of financing, which isn’t possible for modern direct-to-consumer e-commerce businesses who sell direct to consumer.

When obtaining traditional financing it can be a burden to produce the required documents, including:

  • Balance sheets.
  • Sales forecasts for 2+ years (or however long the loan is for).
  • Tax returns for 2+ years.
  • Inventory lists (this may need to be updated monthly).
  • Profit/loss statements for 2+ years.

Modern alternatives for inventory financing

At this point you may be thinking, “I like the sound of the benefits associated with inventory financing but don’t like the sound of all the burdensome aspects associated with traditional loans.”

Are there some other options available that don’t have the same downsides? Over the past few years, there have been a few technology-first solutions that may be a good fit.

Kickpay

Built specifically for ecommerce sellers, Kickpay unlocks the capital you have tied up in inventory, or pays your manufacturer directly for new inventory, and only gets paid back when goods ship to your customers.

Pros

  • No documentation needed.
  • No impact to personal credit score.
  • Only pay back the loan when inventory is shipped to customer.
  • Can qualify with only 3 months of sales history.

Cons

  • Can’t finance work-in-progress
  • Not good for self-fulfillers (you need to use a third-party – you can see the list of the Fulfillment centers Kickpay is integrated with here.

Inventory crowdfunding

This is a great way to leverage the community to finance work-in-progress inventory.

Pros:

  • Can finance work-in-progress.
  • Faster qualification than traditional loans.
  • No impact to personal credit score.

Cons

  • Can’t unlock value tied to inventory already in stock.
  • Payback may not be tied to cash flow.

Merchant Cash Advance

The financier makes an estimate on how much revenue your business will make over the next 3-6 months and forwards a certain percentage to you. You then pay back a certain percentage of sales on a fixed schedule (daily or weekly).

Pros

  • No impact to personal credit score.
  • No documentation needed.
  • Only pay back when company makes a sale.

Cons

  • You are generally offered smaller financing amounts, especially if your business has multiple sales channels.

Conclusion

Financing inventory is a smart thing to do for companies that have a large cost center associated with inventory. This can be especially significant around the seasonal period since it maximizes the sales potential of the business by unlocking capital.

Picking the correct financing option is now easier than ever with more modern solutions on the market. In order to pick the best one, you should ask yourself a few key questions:

  • When do you need the cash: at the down payment for inventory, on shipment from your manufacturer, or after?
  • What do you need to use the cash for: paying for inventory or unlocking capital tied up in inventory you already have for marketing, R&D, etc.? 
  • When do you want to pay back the financing: in a large lump sum or ongoing in smaller increments? 

By answering these questions accurately it will point you towards the most appropriate form of financing. 

If you’re interested in learning more about Kickpay’s inventory financing head over here.

About the author

Andrew McCalister

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