What Is An Inventory Line Of Credit (And Who Should Use One?)

An inventory line of credit is similar to any other line of credit but is meant to finance the inventory you need to create your product. You’ll get a certain credit limit that you can use to buy inventory, you’ll pay down that credit limit and it becomes available for use again later. Similar to a credit card or a traditional business line of credit, you’ll pay interest on your balance that you hold until you pay it off in full.

Key Points:

• An inventory line of credit works similarly to any other business line of credit, in that you can use it over and over again.  
• Be prepared to have a good credit score, or else you’ll pay very high interest rates on your credit line. 
• Seasonal businesses that have fluctuating inventory needs will benefit most from a line of credit for inventory. 

What Is Inventory Financing?

Inventory financing is a type of financing that allows businesses to borrow money against the value of their inventory. This type of financing is designed to help businesses manage their cash flow by providing them with the capital needed to purchase inventory, without having to rely solely on their own cash reserves. Inventory financing can take many forms, including secured loans, lines of credit, and asset-based lending.

Is Collateral Necessary For Inventory Lines Of Credit?

Collateral requirements for inventory lines of credit can vary depending on the lender and the specific terms of the credit agreement. Some lenders may require collateral, while others may not.

In general, collateral refers to assets that the lender can seize and sell in the event that the borrower is unable to repay the loan. In the case of an inventory line of credit, the inventory itself can serve as collateral. The lender may require the business to pledge a percentage of its inventory value as collateral, which can provide the lender with some protection in the event that the business is unable to repay the loan.

However, not all lenders require collateral for inventory lines of credit. Some lenders may offer unsecured lines of credit, which do not require any collateral. These types of lines of credit may have stricter credit requirements, such as a higher credit score or longer business history, in order to mitigate the lender's risk.

Whether collateral is necessary for an inventory line of credit depends on the lender and the specific terms of the credit agreement. Businesses should carefully review the terms and requirements of any potential lenders before deciding on an inventory line of credit.

What Issues Does It Solve And How Does It Work?

The main issue an inventory line of credit solves is how to handle a sudden change in inventory needs. Every business would love an influx in orders for the product they sell, but when you don’t have the inventory on hand to fulfill those orders, things can get stressful quickly, especially if you don’t have the cash on hand to order more.

You can apply for an inventory line of credit before you have the cash flow issue or as it happens. You’re getting a credit line, not a loan, so you can use the line only as you need to. Once you use the line, as long as you pay it back, you can use it again. The main benefit of this is your funding is more flexible.

Types Of Inventory Financing

There are two main types of inventory financing: loans and lines of credit. Both provide capital that businesses can use to purchase extra supplies or inventory, but each offers its own set of pros and cons. 

Inventory Loans

Inventory loans are similar to other business loans. You get a lump sum of money that you can then use to purchase inventory. The loan amount the lender is willing to give you is mostly dependent on the value of the inventory you plan to purchase. You’ll have set monthly payments that you’ll pay over the life of the loan and you’ll pay interest within that loan payment.

Inventory Lines Of Credit

Inventory lines of credit work more similarly to credit cards. Rather than a lump sum of money you spend all at once, you’re given a credit line you can spend on over and over again. Your credit line is often determined by your sales history rather than the exact price of the inventory. Since they have higher interest rates, lines of credit are best viewed as short-term solutions. 

Who Should Consider An Inventory Line Of Credit?

Inventory lines of credit will be better for some businesses, but not for others. If you meet one or more of the descriptions below, you may want to consider an inventory line of credit.

Businesses with sudden inventory changes: Businesses that have a sudden influx of customers during seasonal times can use inventory lines of credit to prepare. They can leave the line dormant for the rest of the year, only drawing on it during busy seasons.

Businesses looking for short-term funding: Lines of credit are a temporary solution and one that’s often more convenient than other forms of financing.

Businesses with good credit: Good credit borrowers will get the most out of inventory lines of credit. They’ll pay substantially less in interest and may not have to put up collateral to secure the credit line.

How Can An Inventory Line Of Credit Help Your Business? 

An inventory line of credit can help your business in several ways, including:

Maintaining adequate inventory levels: An inventory line of credit allows you to maintain adequate inventory levels to meet customer demand. With this type of financing, you can purchase inventory in bulk or as needed, without having to rely solely on your own cash reserves.

Improving cash flow: An inventory line of credit can improve your cash flow by providing you with the funds needed to purchase inventory, without affecting your working capital. This can help you manage your cash flow more effectively and avoid cash flow shortages.

Taking advantage of bulk discounts: With an inventory line of credit, you can purchase inventory in bulk, which can often result in lower costs per unit. This can help you save money and increase your profit margins.

Expanding your business: An inventory line of credit can provide you with the capital needed to expand your business by increasing your inventory levels, adding new product lines, or opening new locations.

Managing seasonal fluctuations: If your business experiences seasonal fluctuations in sales, an inventory line of credit can help you maintain steady inventory levels throughout the year, without having to rely on your own cash reserves.

An inventory line of credit can provide your business with the capital needed to purchase inventory, manage cash flow, and take advantage of growth opportunities. It can be a valuable financing tool for businesses that rely on inventory to generate revenue.

Pros And Cons Of An Inventory Line Of Credit

Any financial product has its pros and cons.

Here’s a table outlining the pros and cons of an inventory line of credit:

An inventory line of credit can be a valuable financing tool for businesses that rely on inventory to generate revenue. However, it's important to carefully consider the potential risks and benefits before deciding if it's the right choice for your business.

How To Qualify For An Inventory LOC

To qualify for an inventory line of credit, there are several factors that lenders typically consider:

Credit score: Lenders will often review the business owner's personal credit score, as well as the business's credit history. A good credit score demonstrates the borrower's ability to manage credit responsibly and can increase their chances of approval.

Financial statements: Lenders will typically request financial statements, such as balance sheets, income statements, and cash flow statements, to evaluate the business's financial health and ability to repay the loan.

Inventory value: Lenders will assess the value of the business's inventory to determine the amount of the line of credit. Generally, lenders will offer a percentage of the inventory value as the line of credit.

Collateral: Some lenders may require collateral, such as a pledge of inventory or other business assets, to secure the loan.

Business history: Lenders may consider the length of time the business has been operating, as well as its industry and market position, when evaluating the loan application.

Cash flow: Lenders will typically evaluate the business's cash flow to ensure that it has the ability to repay the loan. This may involve reviewing bank statements, accounts receivable, and accounts payable.

It's important to note that the specific requirements for qualifying for an inventory line of credit can vary depending on the lender and the terms of the credit agreement. Businesses should carefully review the requirements and terms of any potential lenders before applying for an inventory line of credit.

What Is The Application Process? 

The application process for an inventory line of credit is fairly simple as long as you have the documents you need and understand the qualifications. Here’s a quick step-by-step guide on how to apply for a line of credit:

Determine the cost of your inventory: One of the first questions you’ll be asked is how much you think you’ll need in credit. This doesn’t necessarily equal the amount you’ll be approved for, but with clear documentation of how much you’ve sold in the past and your inventory turnover rate, lenders will know how much you can really handle for a credit line.

Choose your lender type and lender: Before applying, you need to first decide what type of lender you want to work with. Are you looking for a local credit union or do you prefer the larger selection that big banks offer? Additionally, make a list of lenders (you can find some here) and compare their terms.

Gather necessary business documents: The exact documents you’ll need will differ between lenders, but you’ll at least need to be able to prove how long you’ve been in business and how much your business makes in revenue each month. Include profit and loss reports, tax returns, and other accounting documents.

Prepare collateral: If you’re providing collateral, the lender will require documentation of that collateral’s value.

Apply and wait: After you’ve gathered all your info you can enter and hit “apply.” Your wait time will vary. Online lenders can often get your money to you in a day or two while big banks and credit unions may take a few weeks.

Where To Get Inventory Line Of Credit

Inventory lines of credit can be found through a couple of means. Which works best for you depends on your financial health and simply your personal preferences.

Banks And Credit Unions

Brick-and-mortar banks and credit unions offer inventory lines of credit for most businesses. Big banks offer a wider array of borrowing limits and terms while credit unions cater to lower credit borrowers, offering a more limited selection of credit lines.

Online Lenders

Online lenders like American Express® Business Line of Credit offer inventory lines of credit with convenient application process. Borrowers must be at least 18 years old with a minimum FICO score of 640, at least 12 months in business, and have an average monthly revenue of at least $3,000. Borrowers that qualify, may enjoy a credit line between $2,000 and $250,000, however, all businesses are unique and are subject to approval and review.

Other Ways To Finance Inventory

Inventory-specific financing may not be the best option for all borrowers. It may not even be possible for those without the right credit profile. Thankfully, there are other options readily available for all types of borrowers.

Purchase order financing: This is a cash advance business owners can use to fulfill a large number of purchase orders. This isn’t technically a loan, as the customer pays the purchase order company directly once you’ve billed them for their order. You’ll pay a substantial fee to use a service like this, so tread carefully

Crowdfunding: Crowdfunding, also known as peer-to-peer loans, works similarly to any other loan but they’re backed by investors rather than banks. Companies like Prosper and Upstart offer loans that have been funded in small increments by investors who earn a return from the interest you pay.

SBA loans: Small business loans offered through the SBA can be an immense help in funding inventory needs. These loans are definitely more difficult to qualify for, but they offer substantially lower interest rates

Working capital loans: Working capital loans are meant to cover your day-to-day business expenses. They’re short-term loans, often with more flexibility than other business loan types.

How Much Can You Borrow With An Inventory Line Of Credit?

The amount that you can borrow with an inventory line of credit will depend on several factors, including the value of your inventory and the lender's policies. In general, lenders will offer a line of credit that is a percentage of the value of your inventory, often ranging from 50% to 80%.

For example, if your inventory is valued at $100,000, a lender offering an inventory line of credit at 70% of inventory value would provide a line of credit for $70,000.

However, it's important to note that the percentage offered by lenders can vary, and some lenders may offer higher or lower percentages based on factors such as the borrower's creditworthiness, the age and condition of the inventory, and the overall financial health of the business.

It's also important to consider the repayment terms of the line of credit. Some lenders may require that the line of credit be repaid on a specific schedule, while others may allow the borrower to repay the line of credit based on inventory sales.

It's important to carefully review the terms and conditions of any inventory line of credit agreement before accepting it, to ensure that the terms are favorable and manageable for your business.

How To Use An Inventory Line Of Credit To Manage Seasonal Fluctuations

Managing seasonal fluctuations can be a challenge for businesses, particularly those that rely on inventory to generate revenue.An inventory line of credit can be a useful tool for managing these fluctuations and ensuring that the business has the necessary inventory levels to meet demand during peak seasons. Here are some steps to effectively use an inventory line of credit to manage seasonal fluctuations:

Understand your seasonal inventory needs: Start by reviewing your sales data from previous years to identify patterns and fluctuations in demand. This will help you determine the inventory levels needed to meet peak season demands.

Estimate your inventory costs: Once you've determined your seasonal inventory needs, estimate the cost of acquiring the necessary inventory. This will give you an idea of how much you may need to borrow with an inventory line of credit.

Apply for an inventory line of credit: Once you have estimated the amount needed, apply for an inventory line of credit with a lender that offers favorable terms, such as a low interest rate and flexible repayment terms.

Borrow only what you need: When using an inventory line of credit to manage seasonal fluctuations, it's important to borrow only what you need. Borrowing too much can result in unnecessary interest charges and may be difficult to repay.

Monitor your inventory levels: Once you've obtained the line of credit, closely monitor your inventory levels to ensure that you are maintaining appropriate levels. This will help you avoid stockouts and ensure that you are able to meet demand during peak seasons.

Repay the line of credit: Once the seasonal demand has passed and inventory levels have stabilized, begin repaying the inventory line of credit. This will help minimize interest charges and ensure that the business is in good financial standing for future seasonal fluctuations.

An inventory line of credit can be a valuable tool for managing seasonal fluctuations and ensuring that your business has the necessary inventory levels to meet demand during peak seasons. However, it's important to use the line of credit responsibly and ensure that the repayment terms are favorable and manageable for your business.

What Are The Fees Associated With An Inventory Line Of Credit?

The fees associated with an inventory line of credit can vary depending on the lender and the terms of the line of credit. Here are some common fees to look out for:

Interest rate: The interest rate is the primary fee associated with an inventory line of credit. It's important to compare rates from multiple lenders to ensure that you are getting a competitive rate. The interest rate can be fixed or variable, and may be based on the prime rate or another benchmark rate.

Origination fee: Some lenders may charge an origination fee when you apply for an inventory line of credit. This fee covers the lender's administrative costs associated with processing your application.

Annual fee: Some lenders may charge an annual fee for the use of the line of credit. This fee is typically a percentage of the credit limit and is charged annually.

Late payment fee: If you miss a payment on your inventory line of credit, you may be charged a late payment fee. This fee can vary depending on the lender and the terms of the line of credit.

Prepayment penalty: Some lenders may charge a prepayment penalty if you pay off the line of credit early. This fee is intended to compensate the lender for the interest they would have earned if you had continued to borrow from the line of credit.

Collateral valuation fee: In some cases, a lender may charge a fee to assess the value of your inventory, which will be used as collateral for the line of credit.

It's important to carefully review the terms and conditions of any inventory line of credit agreement to understand the fees associated with the line of credit. By doing so, you can ensure that you are getting a line of credit with favorable terms and that the fees associated with the line of credit are manageable for your business.

Final Words

An inventory line of credit can be a valuable tool for businesses that need to finance inventory purchases and manage seasonal fluctuations. By understanding the qualifications and fees associated with an inventory line of credit, businesses can determine whether this financing option is right for them.