Inventory financing is the extension of a short-term loan to a business, so that it can acquire goods that can then be sold. The proceeds from these sales are then used to pay down the loan. If the borrower is unable to sell the goods, then the lender can take possession of the goods, which are collateral for the loan. Inventory financing is especially useful in the following situations:
- Startup businesses. A startup company may not have sufficient invested funds to acquire inventory, and so needs a loan to do so.
- Seasonal sales. A company requires a significant cash investment in order to ramp up for a short, intense selling season.
- Short payment terms. The company is required to pay its suppliers within a shorter period of time than the credit period it allows its customers, creating a cash shortfall during the interim.
Many lenders do not offer inventory financing, or only at high interest rates, on the grounds that they may not be able to sell off the inventory being held by the borrower in the event of a default. They must also expend resources to keep close watch over the inventory being held by their clients. To minimize their potential losses, lenders may only extend loans in amounts that are substantially less than the value of the inventory being acquired, such as 70% of the purchase price.
The high cost of inventory financing usually means that companies only use it as a financing source after all other financing alternatives have been explored.