Every ecommerce business’ biggest fear? Running out of inventory.
In many ways selling online has become much easier. There are a thousand tools out there to help you sell and reach new customers, and global ecommerce sales have more than doubled since 2019.
However, right now it’s never been harder to secure inventory for your business. Shipping costs have sharply increased, supply chains are continually challenged by world events, and growing demand on suppliers has driven prices up.
If you’ve ever experienced a stockout, you’ll know how stressful it is to hand your sales directly to your competitors!
But if you’re a business owner in this position, you’ll always have the option to take out an inventory loan to cover the costs of making sure you’re able to meet demand.
We’ve created this in-depth guide to help you understand the ins and outs of inventory loans, so you know whether they’re the right choice for you.
What are inventory loans?
Inventory loans are a short term loan that ecommerce and retail business owners use to purchase inventory.
Similar to your standard business loan, inventory loans are paid back in monthly installments over a fixed period, or as a lump sum some time after you purchased inventory.
Unlike other business loans, inventory loans don’t require you to offer personal assets like a house, car, or equipment as collateral. Instead, the merchandise you plan to purchase, or inventory you already own, works as collateral for the loan.
Inventory loans are a form of short term business loan for businesses who need to purchase inventory.
Why choose inventory loans?
Inventory loans have one purpose: to help you buy inventory for your business.
If you’re seeing more demand than you planned for, or the inventory costs are more than you expected, then you may need to use an inventory loan to help you pay for your stock.
This form of inventory financing can be a lifeline for businesses with short-term cashflow issues that need a little help to buy inventory.
When small business owners can use inventory loans
Here are some of the most common reasons a small business would apply for an inventory loan:
- They need cover for short term cash shortages
- They need to prepare and stockpile inventory for busy seasons like Black Friday and Christmas
- They want to expand product lines
- They need to unlock capital tied up in existing inventory
- They need to secure cash upfront to keep up with customer demand
But before applying for inventory loans, you’ll need a clear plan to sell the stock you buy at a profit. If you don’t sell the stock, you’ll struggle to make repayments and risk losing the inventory.
Inventory loans vs an inventory line of credit
Inventory financing is sometimes used as an umbrella term for two funding types: inventory loans and an inventory line of credit.
In both, the money is used for purchasing inventory and that inventory is then used to secure the loan.
Standard inventory loans work like most other loans. If you need further financing, you have to start the process all over again.
On the other hand, an inventory line of credit allows for ongoing, as-needed funding, just like a regular business line of credit. This can be a good option for business owners who think they’ll need financing again in the future. For most businesses, an inventory loan is a good place to start before they commit to a line of credit.
Which businesses benefit from inventory loans?
Inventory loans are most beneficial to small businesses that sell products online or in-store. Larger, more established companies find it easier to get a line of credit that covers inventory costs, so are less likely to apply for an inventory loan.
So if your small business sees strong, predictable sales, an inventory financing loan is probably a good option. That’s because the sales you’re about to make from the inventory can quickly cover the costs associated with the loan.
Eligibility for inventory business loans
It’s worth keeping in mind that different banks and online lenders may have unique terms that determine the eligibility of your business for an inventory business loan.
In general, though, your business should meet the following requirements to qualify:
In business for at least a year
Your business needs to have been generating revenue for at least a year. The longer you’ve been in business, the more comprehensive your sales history is, and the higher your chances of getting a loan approved.
It’s pretty rare for a brand new business to be approved for an inventory loan, but that doesn’t mean you won’t be able to find a lender willing to take the risk in exchange for a higher cost loan.
You will need to prove that your business is profitable and that you can repay the loan.
Inventory loan lenders will determine your eligibility based on your business’s previous financial and inventory records, so make sure you’ve got a detailed sales history report ready.
The report should include inventory turnover, and projections for revenue from sales.
A detailed inventory system
Lenders can be very particular about inventory control and product movement. They want to know exactly where the product is sitting and where it’s going.
You’ll need to provide them with regular reports on shipping and returns of products, accounts receivable or sale order receipts.
No major credit violation
Lenders run a credit check to see your business credit history. Major credit violations in the businesses’ recent history such as bankruptcy, repossession, and tax liens could prevent the loan from getting approved.
The advantages of inventory loans
No need for a personal guarantee
You don’t need to put up your home, car, or any other personal assets as collateral. So, if you don’t sell all of your stock, you can rest assured you won’t lose your house.
The only thing at risk are your business assets — for inventory loans that means the inventory you purchased.
Considering that you are eligible and have all of your documents in order, getting an inventory business loan is quicker than other conventional business loans.
Meet customer demand
Inventory loans help you ensure that your warehouses are well-stocked during peak seasons—meaning more demand means more panic more sales!
Improved cash flow
You can free up cash otherwise tied up in inventory. Think of all the marketing campaigns you could fund to help sell the stock you’ve just purchased!
No personal credit score required
No need to worry about your personal credit score—or lack thereof—when applying for inventory loans. Instead inventory loan providers usually check the credit history of your business.
The disadvantages of inventory loans
It’s tough to get approval
It can take a while for lenders to assess your application, especially if it’s for a new product. Lenders move quicker to approve inventory loans for businesses that have already proven their products are successful.
The interest rates are higher
Because inventory loans do not require personal guarantees, lenders offset the risk by charging higher interest rates. For inventory loans, interest rates typically hover around 8-10%.
You may need further business financing
You’ll probably need to turn to other sources of funding alongside inventory loans to meaningfully grow your business... that’s because you can only use inventory loans to buy inventory!
How to know if you need an inventory loan
Inventory loans are there for retailers, either physical or online, who don’t have enough capital to buy the inventory they need.
They may not have all of the capital needed to:
- Bulk purchase stock at a discount to save money in the long run
- Bring in enough inventory to cover peak trading periods like Black Friday
- Buy inventory and increase cash flow to other areas of the business
- Meet customer demand as their business grows
How to apply for an inventory loan
Step 1: Determine the amount and type of inventory needed
The first step for applying for an inventory loan is deciding how much money you will need and what you’re going to spend it on.
To decide what you need, take a close look at patterns in sales volume and seasonality, and consider economic factors that may affect customer activity.
Overestimating your needs can leave you with hefty payments and unsold inventory—while underestimating can leave you scrambling for more stock or running back to the lender for additional inventory financing.
It’s also a good idea to apply for a loan for inventory that you already have a track record of selling, as lenders will be more willing to give you the loan.
Step 2: Get your financial records ready
Before applying for an inventory loan, ensure that you get all the documentation you need ready. This documentation should give the lender a comprehensive overview of your company’s financial standing.
The financial documents that you’ll need to prepare include:
- Balance sheets
- Profit and loss statements
- Business bank statements
- Inventory list
- Inventory management records
- Sales forecast
- Business tax returns
Step 3: Complete the application
Once you’ve got all of your financial documentation ready, you can complete the application form and submit it with your documents. The form will generally include basic information like business owner name, business name, and the amount you are requesting to borrow.
If the lender determines that you are eligible for the inventory loan, you will then go into the ‘Due Diligence Period’. Due diligence is the investigation of your business.
Step 4: Go through the due diligence process
Since due diligence is a lengthy process, many lenders will ask you to sign a loan agreement before it is complete. This agreement reduces the risk that you decide not to follow through with the loan.
They want to know that they’re not wasting their time putting in the hard work of due diligence, all for you to change your mind and cancel the application.
During the due diligence process, you may also need to submit a field audit of your business. A lender representative will visit your office space, warehouse, facility, or wherever you store your inventory.
Remember your stock will be theirs if you are unable to pay back the loan. They want to ensure the inventory is kept safe by examining the conditions of the stock's location and the existing stock held there.
Step 5: Review offer and wait for final approval
Once you’ve gone through the initial review of your application and passed due diligence, the lender will present you with a preliminary offer. The offer will include the details of the loan, including interest rates and terms.
Note that this is non-binding and not the final offer. Once your application is complete, you’ll have to wait for a final decision. Don’t fret though, by this time you should have a good sense of whether or not you’ll be approved.
Step 6: Submit final paperwork and receive funding
Finally, you’ll get to a point where you just have to sign the final paperwork, including the official contract detailing the loan, rate, and terms.
Once that’s all done, you’ll receive the funding. It should come through in just a few days.
Inventory loans in a nutshell
Applying for an inventory loan is a great option for ecommerce and retail businesses who want to purchase additional inventory. They could be looking to stock up on products in the lead up to peak seasons, to secure a discount deal on bulk purchasing, or to free up cash to spend on other areas of the business.
It’s important to remember that they can come with high interest rates and should only be used for purchasing inventory. But if your business is in a good place financially and could use more stock, then it may be worthwhile to look for an inventory loan provider.