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The Pros and Cons of Inventory Financing

Using Inventory as Collateral for Your Small-Business Loan

Inventory financingInventory financing is a common funding resource among small businesses that have high value inventory and/or a solid clientele. With this type of loan, a company’s inventory is used as collateral in securing financing. And because the inventory usually has such a high monetary value in these circumstances, lenders often look at these types of borrowers as being low-risk.

What Is Needed in Order to Qualify for Inventory Financing?

Most lenders will only grant this type of financing to companies that have a certificate of incorporation. Other documents usually required for this type of financing include:

  • Tax ID papers
  • Driver’s license
  • Utility bills
  • Bank statements from the previous three months
  • Inventory list
  • Invoices
  • Business tax returns for the past two years
  • Personal tax returns for the past two years

The Advantages of Inventory Financing

Inventory financing offers a small business a number of attractive benefits. For starters, it is a type of financing that does not get mentioned on the company’s credit report. This means that the amount borrowed will not affect the company’s debt-to-income ratio.

Applying for inventory financing also provides the borrower with a relatively quick decision time; in most cases, it takes less than two weeks for the lender to process the loan. There is little paperwork required with this application, and inventory financing typically costs less than credit cards and other forms of financing.

Loans that are based on a company’s inventory value also tend to have low closing costs, floating rates, and no prepayment penalties.

The Disadvantages of Inventory Financing

Unlike a traditional small-business loan, an inventory financing loan requires a borrower to keep in constant contact with the lender. Every month, the borrower must provide the lender with an update on the company’s inventory count and average turn-around time. In addition, a lender may also require the use of a UCC lien. UCC, which stands for Uniform Commercial Code, is a type of lien commonly utilized when a borrower pledges collateral to the lender in exchange for the loan.

Inventory financing, because it usually carries a floating interest rate, can also suffer from interest rate hikes during times when the national rate is increased.  These loans also tend to have attractive low promotional interest rates that increase after the first year.

If you are interested in inventory financing, and your small business has the inventory value to support this type of loan, it may be a good funding source for your business — as long as you read the terms of the loan agreement and fully understand what you are agreeing to. This type of loan offers pros and cons to the borrower, so in order to get the most value out of it, you should compare it against other types of financing to truly determine if using your inventory as collateral is the right move for your company.

Dave Donovan

Author:

Dave Donovan has written extensively for the web with a primary focus on articles targeting finance and business.