Inventory Financing: Understanding the Perks in Stock

Let’s begin with the very basics: why is financing important? The fact is that financing is among the most significant factors to run a business for both medium and large enterprises. To keep the business running, working capital and money are both necessary. Now, to secure this, companies tend to rely on banks and lenders. Securing a loan is not an easy process; it involves highly strict due diligence, meeting regulatory requirements, having a good credit history, and of course, a reliable backup to ensure the timely repayment of the credit.

If the bank or lender finds out that the borrower would be unable to pay them back in time, the application for financing is mostly outrightly rejected. Borrowers not being granted the requisite finance is quite common. This, in turn, highly limits their scope of smoothly running their business. Securing bank financing is indeed not only a tedious process; it also places the company in debt – not a good position for a business to find itself in. What should a business do then? If it’s a medium or large enterprise, its goal should be to consider options of financing where they can stay away from falling into significant debt. How? Enter: trade finance.

Historically, international trade finance has been dependent on traditional methods such as documentary collections and letters of credit, which have been heavily burdened by paper-based processes and a reliance on legacy systems, often aging. However, since the financial crisis of 2008, there has been a rise in the efforts towards finding newer, more efficient, and increasingly effective ways to go about trade financing. This includes supply chain finance. Why is this important?

Supply chain finance is, without a doubt, a crucial enabler of international trade. As we’ve mentioned before, traditional financial instruments, such as letters of credit and guarantees, are not quite favored by many companies owing to the relatively high operational costs and time-consuming processes that are involved. Technology is changing things, however. Distributed ledger and other technological innovations bring revolutionary advances in trade and supply chain finance to the forefront by reducing costs and enhancing ease of use. 

Understanding Supply Chain Financing

Supply chain finance, also known as supplier finance or “SCF,” is a cash-flow solution helping businesses to free up their working capital that gets encumbered in global supply chains. Essentially, SCF is a set of technology-based business and financing processes that link multiple stakeholders in a given transaction. It helps reduce financing costs and enhances businesses’ efficiency. How it traditionally works is that suppliers sell their invoices or ‘receivables’ at a discount to banks or other financial service providers (factors). In exchange, suppliers receive quicker access to money for working capital. The solution works well for industries including automotives, manufacturing, electronics, and retail, among others.

Furthermore, as we’ve previously mentioned, the growing applications of tech like the Internet of Things, blockchain, and artificial intelligence have served to boost the growth of international trade around the world. Time and cost pertaining to SCF can be significantly reduced through digitization and the use of more advanced technologies. Companies, globally, can leverage new tools and technologies for transforming paper-based documentation into electronic formats, in an endeavor to reduce trade barriers that currently exist, unlocking the value of their asset.

Globally, with regard to financing, third-party technology platforms and crowdfunding platforms have also recently emerged. Established supply chain finance solutions vendors such as Supply@ME offer many off-the-shelf, innovative supply chain finance platforms where investors (funds, banks) can finance several supply chains, and trading & manufacturing companies can borrow new money, monetizing their asset (firstly, inventory).

Understanding How Inventory Financing Works

Inventory financing can be understood as ‘short-term working capital loan secured against the existing inventories of the company, which is then converted into sales.’ This inventory can then be used as collateral to secure the desired loan. Who uses inventory financing? Primarily seasonal businesses, dealerships, as well as retailers and wholesalers. Such parties tend to use this kind of financing to cover short-term cash flow gaps, prepare and launch a new product, or in general, to increase their sales. However, it’s important to note that banks and lenders finance only a certain portion of the inventory’s appraised value. What does this mean? The liquidation value of the inventory in question is what is used, as against the market value and as appraised by the lender(s).

It stands to reason that when someone applies for such financing, the borrower's credit history and business finances are considered in tandem with the requisite due diligence. For this, factors such as the company’s inventory management system, the value of inventory, loss or damage rate, profit margins, and inventory turnover, among others, are closely looked at.

It’s interesting to note that as per recent data provided by the Electronic Transactions Association, about 51% of small-business owners state that inventory control is their chief reason for borrowing money. It’s evident that inventory loans are one of the many working capital options available if one needs short-term cash to replenish low inventory. So how does inventory financing differ from other types of loans, or for that matter, credit? The answer lies in the fact that inventory financing is designed with a focus on being able to satisfy a range of inventory requirements. So the question that arises here is: what are some of the chief advantages of inventory financing?

Key Advantages of Inventory Financing

  1. Short-term cash infusion for inventory purchases: It is a good short-term financing solution for business. In the situation where a company has less inventory and cash, inventory loans can help the company get out of that difficult spot. By securing inventory loan companies can purchase the appropriate amount of inventory, and in turn, improve their business’s sales moving forward.
  2. Helpful in business expansion: Mid and large-sized businesses are constantly expanding and improving their product lines. The expansion involves a lot of capital infusion. Inventory loans enable them to expand their product lines, which will help them to increase sales channels. Due to this, an inventory loan gives a business the flexibility to expand without draining their business’s cash.
  3. A stable and revolving source of funding: Once the due diligence phase has been completed, the amount of required paperwork in order to grant the fund during the contract life cycle is less than a typical bank loan, and most decisions are made within a few days. Loans based on a business’ inventory have lower or variable interest rates, low closing costs, and no prepayment penalties, making it a fairly low-risk proposition for the borrower.
  4. In specific and innovative cases, inventory financing doesn't affect the borrower's credit report: Special services related to Inventory financing (e.g., “true-sale” – see below) don’t count on the borrower's credit report; therefore, it will not impact their debt-to-income ratio which is a very important factor; especially for growing mid-sized businesses.

Along with the advantages as described above, accessibility to inventory financing is expected to become far easier and less time-consuming thanks to newer technologies and financing platforms. Companies are now coming up with financing platforms with technologies that can automate processes while reducing the amount of documentation needed. This, in turn, reduces the processing time for disbursing the funds.

Looking at ‘True Sales’ in Inventory Financing

Now, even though inventory finance is usually provided as a loan or an advance against assets that remain on the borrower’s balance sheet, in certain instances, a ‘true-sale’ may occur, and the inventory could be taken off the balance sheet of the initial inventory owner. In the case of such an arrangement, the financier gets into a sale and repurchase – or repo – agreement, for the goods that are being financed. In more rare instances that involve true-sale, there may not be a repo, but a more general necessity to retire the funding. Furthermore, another model for receiving inventory finance could involve something called ‘Floor Plan Finance.’ In such a model, the stock that is depleted is given to the distributor by a manufacturer and then financed by a finance provider. It should be noted that when it comes to inventory financing through a true-sale, it usually managed by Specialized Entities which, in turn, have to recognize the said inventory into its own balance sheet.

It is against this background that initiatives such as Supply@ME, to cite an example, are considered disruptive – through initiatives like this, corporates can receive money and obtain asset derecognition meanwhile funders can manage their credit lines, gaining attractive returns thanks to investing to this new low-risk asset class.

It suffices to say that for now, that there are indeed many perks to inventory financing; companies are now realizing that it’s time they started stocking up on them for boosting their businesses’ profitability.