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How does an inventory line of credit work?


Business owners looking to increase cash flow for inventory might consider an inventory line of credit. This type of financing can work well for retailers, wholesalers, and seasonal businesses. In this article, we explain how inventory lines of credit work, how they differ from an inventory loan, and which options are best.

How an inventory line of credit works

A business line of credit is a pool of money that businesses can draw on as needed while only paying interest on the amount used. It is also known as a revolving line of credit. Small business financing lenders may be willing to offer an inventory line of credit to a business with varying inventory expenses. If your small business is struggling to stay stocked during peak season or keep up with customer demand, an inventory line of credit can help.

Here are the steps to open a business line of credit.

1. Calculate the total cost of your inventory

First, do the math to determine how much you’ll need to pay to restock your business’ inventory. This number will tell the lender how much they should offer you in financing. Line of credit lenders only cover a certain percentage of the total inventory cost, rather than the total price.

An inventory management system can be helpful in calculating your company’s inventory turnover rate.

2. Find the right lender

Now is the time to find the right financing option. If you decide to go with a line of credit over other small business loans, you’ll want to find out which lenders offer lines of credit. Some (but not all) traditional banks will do this, but many online lenders have the capability.

When comparing options, check whether or not there are drawdown fees that some lenders charge each time you withdraw funds. Additionally, there may be fees for creation, annual service, and monthly maintenance, so check those as well.

3. Request the Inventory Line of Credit

The application process varies by lender. Many online banks offer simple digital applications. Whether you go with a traditional bank or an online lender, they will likely assess your professional and personal credit score, time spent in business, and annual income. Head to Nav’s guide to learn more about how to establish business credit.

4. Get approved and use the funds

Once you get approved, you can use the trade line of credit to purchase products to stock your inventory. If there is a specific drawdown period (explained below) for your line of credit, you may only be able to use the funds during that period.

Remember that interest rates may be higher with inventory lines of credit, as it’s a little riskier than other types of financing.

5. Repay what you owe

Some finance companies have a drawdown period where you can access the funds and pay only the interest. Then there is a repayment period during which you must make monthly payments on the line of credit until it is fully repaid over a certain period of time, usually six to 24 months for online lenders.

Once you’ve fully repaid what you borrowed, you can use the full line of credit again, if needed.

How much can you borrow against inventory?

The loan amount on an inventory line of credit depends on the type of inventory you have and the value of it. Most likely, you will not be able to borrow the full amount needed to purchase inventory.

Typically, lenders offer a wide range between 20% and 80% of the inventory value. And because the value of inventory can decrease over time, a lender may even use the liquidation value of your inventory (which in most cases is likely less than its purchase value) to determine how much to offer you. .

Is collateral required for inventory lines of credit?

With an inventory line of credit, the inventory serves as collateral for the financing. So you don’t have to deposit any business or personal assets before getting an inventory line of credit. While it’s nice not having to offer collateral up front, it also means that if you don’t meet your payments, the lender can seize your business inventory to try and recoup some of their profits. .

What is the difference between an inventory loan and an inventory line of credit?

A line of credit is just one type of loan option you can get for the purpose of storing inventory. Another common solution is a short-term loan from a bank or online lender. Bank loans usually have better repayment terms and lower interest rates than online lenders and give you a lump sum of money.

On the other hand, term loans can be more difficult to obtain and require better credit history and creditworthiness. Traditional banks may also be more reluctant to offer inventory financing because it carries higher risk than other types of financing. This is because you have to sell the inventory to pay them back. They also typically take longer to send funding, while online lenders can send funding as quickly as a day or two after application.

What are the best lenders offering an inventory line of credit?

The type of loan your business needs depends on a variety of factors. But small business owners and startups have great financing options to choose from when choosing an inventory line of credit. Here are some of our favorite picks.

Also, keep in mind that business credit cards can be a great alternative for filling cash gaps and allowing you to purchase additional inventory as needed. Create a free Nav account to see your best business credit card options.

This article was originally written on June 30, 2022.

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