What Is Inventory Financing and How Does It Work?

Inventory financing is a type of small-business loan that helps you buy inventory, or products, for your business and uses the inventory you’re purchasing as collateral on the loan. You can get inventory financing from banks, credit unions and online lenders.

Inventory-heavy businesses that are struggling with cash flow, are looking to expand or add locations or those want to access discounts by buying products in bulk may benefit from this type of asset-based financing.

What is inventory financing?

Inventory financing is a loan used to purchase the finished products or raw materials used to make the products that your business sells.

Inventory financing can be easier to qualify for than more traditional loan options — the inventory you buy serves as collateral on the financing, which means you may not have to put up additional business assets to secure the loan.

You can use inventory financing to:

• Purchase inventory to prepare for your busy season.

• Cover short-term cash flow gaps.

• Buy additional stock to meet increased customer demand.

• Update product offerings or launch products.

• Purchase products in bulk at a discount.

» MORE: Best retail business loans

How does inventory financing work?

Inventory financing can be issued by banks, credit unions and online lenders. The amount of capital you receive from a lender is based on the value of the inventory you want to buy.

Although you may ask for a loan amount equal to the total cost of the inventory you’d like to purchase, many lenders will offer you only a percentage of the inventory’s value. This percentage can range anywhere from 20% to 80%, depending on the type of inventory, your qualifications and the lender.

Because the value of inventory depreciates, offering only a percentage of the inventory’s value mitigates risk for the lender if you default on the loan and they need to sell off your inventory to recover their losses.

Types of inventory financing

Inventory financing can be structured as term loans or lines of credit. The right option for your business will depend on your specific needs.

Key considerations

• Typical APR: Between 6% and 99%.  

• Repayment terms: Six months to seven years.   

• Funding speed: Some online lenders can provide funding within one day, but traditional term loans can take several weeks. 

Inventory loans function like traditional business term loans, in which you receive a specific amount of capital and pay it back, with interest, over a period of time. Term loans may have higher borrowing amounts and longer repayment periods, making them a better choice for financing large, one-time inventory purchases.

Key considerations

• Typical APR: Between 10% and 99%. 

• Repayment terms: Typically six to 24 months. 

• Funding speed: Within the same business day or up to several weeks, depending on the lender. 

An inventory line of credit gives you access to a set amount of money that you can tap into as needed — and you pay back only what you’ve borrowed. These business credit lines are often revolving, meaning once you’ve paid back what you’ve borrowed, you again have access to the maximum approved amount and don’t need to continuously reapply for funding. An inventory line of credit offers more flexibility than a term loan and can be a good option for financing ongoing inventory purchases.

Like term loans, funding speed can vary depending on the type of lender. Unlike with term loans, however, with lines of credit you may make multiple funding requests over the life of the loan. This is something to keep in mind when you’re planning on taking a draw.

» MORE: Business loan vs. line of credit

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Pros and cons of inventory financing

How to get inventory financing

1. Review your qualifications

Most lenders will use your personal credit score, time in business and annual revenue to underwrite your loan application. For inventory financing, they’ll also consider the value of the inventory you’re looking to purchase, as well as any additional collateral you can offer.

Although banks and credit unions typically provide the most competitive rates and terms, you’ll likely need good credit, strong finances and multiple years in business to get funding. Online lenders, on the other hand, are usually more flexible with their qualification requirements. These lenders may work with startups or borrowers with bad credit — but they’ll charge higher interest rates.

Evaluating your business credentials ahead of time can help you better direct your financing search.

2. Compare inventory financing options

You’ll want to research several inventory financing options to determine which one is the best fit for your business. Consider comparing factors such as:

• Repayment terms. Inventory loans often have short repayment terms and may require frequent (daily or weekly) payments. You should make sure that you can afford to repay any potential debt before taking it on.

• Interest rates and fees. Inventory financing may be more expensive than traditional bank or SBA loans. You’ll want to ensure that you understand what the rates and fees are and how they’re charged. If a lender quotes interest as a factor rate, it’s helpful to calculate it into an annual percentage rate to get a better sense of the loan cost.

• Collateral requirements. Some lenders may require you to secure your loan with additional business assets. You’ll want to double check these types of requirements — and determine if you can meet them — before you apply.

• Funding speed. You may be able to get inventory financing from an online lender within 24 hours of approval. Some of these lenders charge higher rates, however, so consider if speed is worth the additional cost.

3. Gather documentation and apply

The business loan application process will vary by lender, but you’ll typically need to provide documentation such as:

• Business and personal bank statements.

• Business and personal tax returns.

• Business financial statements (e.g., profit and loss statement, balance sheet).

• Current inventory list.

• Sales records and projections.

Lenders may ask for a third-party appraisal to assess the value of the inventory you’re looking to purchase. They may also ask about your inventory turnover and inventory management system.

After you submit your application and receive approval, you may get access to funds as quickly as the same day — depending on your lender. Before signing the business loan agreement, however, you’ll want to review it to make sure the terms and rates are correct, and you’re clear about any penalties or fees.

» MORE: What is a prepayment penalty on a business loan?

Alternatives to inventory financing

If you’re having trouble finding or qualifying for inventory financing, there are other options to consider:

• Invoice financing or factoring: Both invoice financing and invoice factoring can help B2B businesses cover gaps in cash flow by advancing money on unpaid customer invoices. With invoice financing, your unpaid invoices serve as collateral on a loan until your customer pays you. With factoring, a company purchases your unpaid invoices at a discount, and takes over collecting the money from your customers. 

• Business credit card: Similar to a line of credit, a business credit card is a revolving line that only charges interest on money you have spent on the card. As you pay down the card, you can spend money on it again. 

• Purchase order (PO) financing: Similar to inventory financing, purchase order financing is a lump sum of money that can be used to cover cash flow gaps. While inventory financing can be used for general inventory needs, however, PO financing is tied to the needs of a specific purchase order. 

• Equipment financing. If your business is not inventory-heavy, but you want a self-collateralizing loan option, equipment financing allows you to purchase business equipment and use it to secure your loan.