Meaning and definition of Inventory Financing
Inventory financing refers to a line of credit or short-term loan made to a company for purchasing products for sale. These products, or inventory, serve as collateral for the loan if the business is unable to sell and repay its loan. Inventory financing is useful, especially, for the businesses that must pay their suppliers in a shorter time period than what is taken in selling the inventory to customers. Moreover, it also provides a solution to seasonal fluctuations in cash flows in addition to helping a business reach a higher sales volume.
As stated by Investopedia, lenders might view inventory financing as a type of unsecured loan for if the business is unable to sell its inventory, the bank might not be able to either.
What companies can benefit from Inventory Financing?
Inventory financing is beneficial for companies with the following features:
- those with tangible inventory (put other way, service business need not apply),
- those with a proven history for sales and good credit as lenders are not really interested in taking possession of the inventory if the owner is unable to make the loan payments
Limitations of Inventory Financing
The inventory financing is featured with certain drawbacks. Some of these include:
- Lenders will most probably require additional security in place to ensure that the collateral is not being disposed improperly.
- Many banks are not known to inventory financing which implies that an extra effort is required to find a banker who is comfortable with it.
- The line of credit might be required to be paid off in full every 12 months and then not used at all for one month.
- If sales decline all of a sudden, two problems come to pass:
- the inventory might be required to be unloaded at a loss, thus undermining the owners’ ability of staying current on the line of credit, and
- the interest charged on loan might undermine the owners ability of keeping production on schedule
- Another drawback of inventory financing is featured in high interest and other fees.
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