While Inventory financing is a common part of an asset-based loan it usually does not generate as much working capital as receivables finance. While the advance rate on accounts receivable is in the 80% to 90% range, inventory financing advance rates usually top off at 50% of the cost of goods or 75% of orderly liquidation value.
Lenders take into consideration the rotation of the inventory and liquidation value among other things when determining the advance rate. Lenders will typically want to keep the amount of money advanced on the inventory to a percentage of the accounts receivable. Conservative lenders will limit the advance on inventory to 33% of the total accounts receivables where more aggressive ABL lenders will go up to 80% of the total accounts receivables. Some lenders will give consideration to seasonality and will allow the inventory advance to exceed the receivables advances, however, will expect to bring the loan back into formula once the season has passed.
Lenders will also classify inventory in different classes such as finished goods, work in progress (WIP) and raw materials. Lenders will usually offer a different advance rate for each of the different classes of inventory. Lenders will exclude any items from the inventory financing portion that are obsolete or considered slow mowing inventory.
Asset Based Lenders will require that the borrower have a perpetual inventory system so that they have real time information related to the collateral. Lenders will not offer inventory finance to companies that do not have a mechanism in place to track inventory. Some lenders will recommend a vendor that can implement a perpetual inventory system if one is not already in place.
Lenders only want to provide inventory finance for goods that are in control of the client. ABL lenders do not like to fund goods in transit, however, can work with third party lenders that will fund the goods while they are on the water.
Inventory Finance is a good solution for companies that must have inventory on hand to fulfill customer needs, however, comes with restrictions and requirements that the borrower must manage.
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