Are You Frustrated Trying To Locate Suitable Inventory
Financing?
If you are having difficulty finding
proper inventory financing, you are definitely
not alone. Loans for inventory can be one of the most
difficult lending instruments to locate and understand.
So why is it difficult to locate?
For a retailer, wholesaler, or manufacturer, inventory
financing has to largely be funded with equity financing
(your own money). Due to the movable nature of most
inventory and the potential fluctuations in price,
inventory is a difficult item for a lender to secure.
Even if a lender does provide financing against your
inventory, what is the lender’s liquidation path in the
event that you don’t make your payment and how many
cents on the dollar will he receive from liquidation,
provided he can take possession of the inventory?
What tends to destroys any interest by lenders is the
high probability of loss in default situations that is
largely beyond the average lenders control or ability to
manage.
Traditional lenders will provide small amount of
inventory financing to established companies with good
cash flow and net worth, but normally won’t do so unless
the accounts receivable are also included in the
financing.
Even then, the lender will assess what they believe to
be the liquidation value of the inventory and lend a
percentage of that value which can end up being less
than 20% of your actual cost to acquire the inventory.
So even in established businesses, inventory tends to be
owner financed.
Inventory Financing Models
There is essentially three inventory financing model,
each with its own variations according to the specific
business parameters involved.
Unlike other types of financing, inventory financing
programs tend to be molded to a particular business
application as there is too much variability for a one
size fits all financing product. This is yet another
reason why most lenders are not interested in financing
inventory.
The first type of inventory financing model is one where
the lender has complete control over the inventory,
usually through the use of a third party warehouse.
Under this model, inventory is purchased with the
lenders funds and stored in a third party warehouse.
Depending on the lender, the inventory may be owned by
you or it may actually be owned by the lender. But in
both cases, the lender has full control.
The lender will release inventory to you as you pay for
it. For example, say you purchased $100,000 worth of
inventory and had it financed under this model. You then
make a sale and have to deliver $25,000 worth of the
inventory. You would have to pay the lender $25,000 plus
the financing costs, and the lender would release that
amount of inventory for delivery. This process would be
repeated for each inventory draw down until all units
are paid for.
The key to making this model work is having enough
free cash flow to pay for the inventory as you need it.
The major benefit to you is that you can get inventory
in a saleable position without having to self finance
the purchase. In many cases where this model is used,
the inventory financer has to pay a manufacturer 50% of
the order cost on order placement or booking and the
remaining 50% of the order cost on shipment from the
factory. This capital outlay can be for several months,
especially if the manufacturing is done over seas.
Again, depending on the model, the financing usually
ranges between 70% and 100% of the inventory cost.
The second type of inventory financing involves purchase
orders. This is most common with wholesalers and brokers
trying to facilitate buy and sell block orders.
If you have a purchase order for a commodity based
product (easy to liquidate) from a well established
purchaser, an inventory lender can potentially finance
the purchase of the inventory required to complete the
sale provided that it is directly shipped to your
customer and provided the customer agrees to pay the
inventory lender directly (basically, you don’t touch
the inventory or the payment). Once payment is received,
the inventory lender will deduct the cost of the
inventory and the financing costs and forward the
balance (margin) to you.
The third most common inventory financing model is an
asset based loan. In this model, the lender has first
claim on all accounts receivable and inventory, and all
incoming funds for the business are deposited into the
asset based lenders account.
Effectively, the asset based lender has complete control
over the cash flow. This allows the lender to manager
their risk more effectively through weekly monitoring of
cash coming in and going out.
The net effect of asset based financing is that the
lender is prepared to free up the equity held in
inventory and receivables so that more inventory can be
purchased to meet demand. The amount of financing
provided is based on the lender’s margining equation
which determines how much financing can be made
available for each dollar of inventory and receivables
held by the business.
Margining is influenced by the age of receivables and
the liquidity of the inventory among other things.
Each of these three models has numerous variations,
but has some basic things in common:
1. The inventory lender reduces risk by controlling a
combination of assets and cash flow.
2. The more certain and predictable the purchase and
sale cycle the, the higher the probability of acquiring
inventory financing.
3. Inventory to be financed must be easy to liquidate
and have enough retail margin to pay for fast
liquidation.
