Inventory financing a short-term loan or line of credit that is used to 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.
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. It is more commonly used by smaller businesses that do not have a sufficient borrowing history to qualify for any other type of loan.