Inventory financing is usually offered in combination with an invoice factoring line. Combining both products allows companies to leverage their assets and further enhance their cash flow. In this article you will learn:
- What is inventory financing?
- What is invoice factoring?
- How do these solutions work together
What is inventory financing?
Inventory financing is a form of asset based finance that allows your company to leverage the inventory that you own. This can be useful if your suppliers are not extending as much credit as you need, or if they are asking for faster payments. Most inventory financing lines work much like a revolving line of credit.
The line allows you to make draw requests as inventory is acquired. This provides the funds you need to operate the business. The line is settled by financing receivables, either by factoring them or by using an asset based loan. To learn more about this solution, please read “How does inventory financing work?”
What is accounts receivable factoring?
Accounts receivable factoring is a form of asset based finance that allows you to finance your accounts receivable. This can be useful if you work with commercial and government clients who pay their invoices in 30 – 60 days. Financing your receivables improves your cash flow and provides funds so you can operate your business. Accounts receivable factoring lines operate similarly to a line of credit.
You can withdraw funds from the line as soon as you invoice customers. You pay back once your customer pays the invoice, which settles the transaction. To learn more, please read “How does accounts receivable financing work?”
How do they work together?
Companies that have cash flow problems should first consider using accounts receivable financing. This solution is simpler to implement and more cost-effective than inventory financing. However, if factoring your invoices does not solve your problem, consider financing your inventory as well.
Inventory financing lines settle through the sale of your product. Once inventory or raw materials are turned into product and sold off to a customer. The sale creates and invoice, which can then be financed. The funds from financing the invoice can be used to settle the inventory line.
Here is a list of the six more important differences between an invoice factoring line and an inventory financing facility:
1) Different but complementary objectives
Both tools are designed to improve your cash flow. However, factoring has the ability to make the biggest and most cost effective impact, so it should be implemented first. Inventory finance, on the other hand, is an add-on option that can be used to further improve working capital.
2) Asset valuations and advances
Invoices are financed by advancing 70% – 80% of their face value. Funding is done net of any credit memos, returns or retainage.
Inventory is usually financed by advancing 70% – 80% a percentage of the inventory’s appraised value. This last point is very important, since the appraised value can be lower than the market value. In turn, this affects the amount of financing you can get. Lenders usually appraise inventory using the Net Orderly Liquidation Value or the Forced Liquidation Value.
3) Qualification requirements
Qualifying for invoice factoring is relatively simple. Your invoices must be free of liens and payable by commercially creditworthy companies. Factoring can be provided to companies that have financial problems and are in turn-around mode.
Qualifying for inventory financing, on the other hand, is more difficult. Your company must have:
- A minimum trading history of two years
- An reliable inventory tracking system using perpetual inventory
- Reasonable good financial statements
- A minimum need of $700,000
- Marketable inventory / raw materials
4) Due diligence costs
Except for very large factoring lines, factoring due diligence costs are usually minimal. Costs can range from a couple hundred dollars, to a few thousand dollars for a complex line that requires a site visit.
The due diligence for an inventory financing line is more complex and time consuming, and therefore more expensive. The lender will need to perform a field examination at your facility (or plants). They will also need to have an appraiser visit your facilities to review your inventory. These out of pocket expenses can add up. Depending on the size of the line, type of inventory, and number of facilities, the due diligence cost can range from $10,000 to $20,000 and up.
Accounts receivable financing lines require minimal maintenance, though some lines require a yearly field examination. Inventory financing lines, on the other hand, usually require quarterly field examinations. These examinations are paid by the client, which adds to your operating costs.
Both lines are flexible and can increase as your business grows. Increasing a factoring line is relatively easy. All you need to do is sell to new creditworthy customers. If your customers credit is approved by the lender, your line will increase automatically.
Increasing an inventory line can be somewhat more complicated. Approving the increase may require some additional due diligence, especially if you are selling new inventory.
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