Inventory financing lets a business borrow against the goods it has in stock. Below is a plain-English definition, the terms lenders use, and a step-by-step walkthrough with a simple example.

What Is Inventory Financing? A Plain-English Definition

Inventory financing is a loan or line of credit secured by the products, parts or materials a business holds for sale or production. The lender estimates what the goods would bring if they had to be sold, lends a share of that figure, and lets your borrowing limit rise and fall with your inventory. You keep the goods, sell them as usual, and repay from the proceeds.

It is a form of asset-based lending, so lenders focus on the collateral, not only on your credit and cash flow.

Key Terms to Know

• Collateral. The assets pledged to secure the loan, here your inventory. Many lenders also take a lien on other business assets.

• Eligible vs. ineligible inventory. Eligible inventory is stock the lender counts toward your limit, usually finished goods and easily resold raw materials. Ineligible stock, such as obsolete or slow-moving items, work-in-process, consigned goods and goods in transit, is left out.

• Net orderly liquidation value (NOLV). An appraiser's estimate of what the inventory would bring in an organized sale, after selling costs. It is often shown as a percentage of cost.

• Advance rate. The percentage of eligible inventory value the lender will lend. It is commonly up to about 50% to 65% of cost or about 80% to 85% of NOLV, depending on the goods.

• Borrowing base. The most you can borrow at a given time: eligible inventory times the advance rate, minus any reserves the lender holds back.

• UCC-1 lien. A public filing, usually with a state filing office, that tells other creditors the lender has a security interest in your inventory.

• Field exam. An on-site review in which an examiner checks your records, tests counts and confirms the collateral matches what you report.

• Borrowing base certificate. A signed report, often monthly, that lists your eligible collateral and calculates how much you can draw.

How Does Inventory Financing Work? Step by Step

1. Application. You share financial statements and inventory listings, aging and turnover reports. The lender checks whether it can value and resell your goods.

2. Term sheet. The lender proposes a facility size, advance rates, fees and conditions, often in a non-binding term sheet.

3. Appraisal and field exam. An appraiser estimates NOLV and a field examiner reviews your records. Their findings shape the final advance rate and eligibility rules.

4. Closing and lien filing. You sign the loan and security agreements, and the lender files a UCC-1. It may also require insurance naming it as loss payee and agreements with any landlord or warehouse holding your goods.

5. First draw. The lender sets your opening borrowing base, and you draw funds to buy stock or pay suppliers.

6. Ongoing reporting. You submit borrowing base certificates on schedule, and the lender may repeat field exams and appraisals.

7. Selling and repaying. As inventory sells, the proceeds pay down the balance, often through an account the lender controls. On a revolving line, repaid amounts can be borrowed again.

8. Renewal or payoff. At maturity you renew, refinance or repay. After payoff, the lender typically files a UCC-3 termination to release its lien.

A Simple Worked Example

Here is how the numbers might look for a distributor whose line advances 85% of NOLV.

• Total inventory at cost: $600,000

• Less ineligible stock: $100,000 of slow-moving items and goods in transit

• Eligible inventory at cost: $500,000

• Appraised NOLV: 60% of cost, or $300,000

• Borrowing base: 85% of $300,000, or $255,000

• Current loan balance: $220,000

• Available to draw: $255,000 minus $220,000, or $35,000

Notice that 85% of a 60% NOLV works out to 51% of cost. That is why $500,000 of eligible inventory supports about half that amount in borrowing.

Now suppose more items age into the slow-moving category, cutting eligible inventory to $400,000 at cost while the balance stays at $220,000. NOLV becomes $240,000 and the borrowing base $204,000. The business is now $16,000 over its borrowing base, an overadvance it would usually have to repay.

How It Differs From Receivables and Purchase Order Financing

All three fund working capital, but each lends against a different point in your sales cycle.

• Inventory financing. The lender advances against goods you own but have not sold. Because it would have to find buyers for that stock, advance rates are lower.

• Receivables financing. The lender advances against invoices customers owe for goods already delivered. Invoices are closer to cash, so advance rates are usually higher, and your customers' credit matters a great deal.

• Purchase order financing. The lender pays your supplier to produce or ship goods for a specific confirmed customer order. It is short term, tied to one order, and repaid when that customer pays.

Many asset-based lenders combine inventory and receivables in one revolving line. When you sell inventory on credit, it moves from the inventory part of your borrowing base to the receivables part.

Signs It Is a Good Fit, and Signs It Is Not

Inventory financing tends to work well when:

• Inventory makes up a large share of your assets and ties up cash you need elsewhere.

• Your products are standard goods with a resale market.

• You track stock accurately by item and location.

• You need to buy ahead of a seasonal peak or a period of growth.

• Your margins comfortably cover interest, fees and reporting costs.

It is probably not the right tool when:

• Your stock is perishable, highly customized, quickly outdated or hard to resell.

• Your inventory records are incomplete or out of date.

• The amount you need is small compared with the cost of appraisals and field exams.

• Your real cash gap comes from slow-paying customers, which receivables financing addresses more directly.

• Sales are falling and stock is not moving.

Common Misconceptions

• "I can borrow the full value of my inventory." Lenders advance a share of a discounted liquidation value, so availability is usually well below what you paid.

• "The lender takes my goods." Outside of certain warehouse arrangements, the inventory stays in your building and you sell it normally. The lender's rights come into play mainly if you default.

• "Once approved, my limit is fixed." Availability moves with each borrowing base certificate as inventory levels and eligibility change.

• "Only struggling companies use it." Many growing and seasonal businesses use it to fund stock ahead of demand.

Frequently Asked Questions

How often do I have to report to the lender?
It depends on the agreement. Monthly borrowing base certificates are common, and some lenders ask for weekly reports on larger or riskier facilities.

Who pays for the appraisal and field exams?
The borrower usually does. Ask for these costs in writing up front, since they add to the total cost of the facility.

Will the UCC-1 lien affect other borrowing?
It can. Other lenders will see the filing, and a second lender may need an agreement with your inventory lender before extending credit against the same assets.

Is inventory financing the same as a business loan?
It is a type of business loan, but approval and size depend heavily on your collateral, and the amount you can draw changes as your inventory does.

Explore Inventory Financing for Your Business

If your business holds inventory and needs working capital to grow, gather a current inventory listing, an aging report and recent financial statements. Then talk with banks or non-bank asset-based lenders about how much your stock could support and which structure fits your sales cycle.