All too often a company needs immediate cash for various needs and they just don’t have it. Some industries require a distributor to pay for a product before they can sell it, requiring them to have cash on hand for their suppliers. Although the company will recoup their money plus a profit, it can be difficult having to pay that much cash up front. Of course, if they don’t have the product, then they can’t resell it and they will be out of business. So what does a company do for cash up front? One common solution is inventory credit.
What is Inventory Credit
Inventory credit is the business practice of using a company’s stock or inventory as collateral for a loan. Ost banks, especially in today’s economy, are reluctant to issue unsecured loans, even to established companies with good credit. But inventory represents a company’s physical assets and has cash value if liquidated.
Inventory credit has been used for centuries. The concept got its start in ancient Rome with agriculture and merchant goods. The practice is used worldwide, especially in third world countries where ownership of land titles (normally used for loans) can be somewhat dubious. One common product that uses inventory credit for financing and can be found in any grocery store is parmesan cheese from Italy. Inventory credit is also used for agricultural businesses in Latin American and Africa, manufacturing, and automobile dealers with a lot of money tied into their inventory.
How Inventory Credit Works
Inventory values can fluctuate depending on the economy and the particular industry of the company. To make sure they do not lose money should inventory values plummet, banks usually only lend up to 60 percent of the total value of the inventory being used. Plus, physical inventory can be liquidated but you would not get the full value for it.
The bank will inspect any inventory before they approve a loan. They will want to know exactly what they are loaning the money for and what kind of condition the collateral is in. If the loan is approved, the bank has the right to inspect the inventory at any time.
When inventory is sold, it is up to the owner to keep track of it. A portion of the profits will need to go towards paying off the loan. Banks tend to frown on companies that borrow money based on inventory credit and then sell the inventory without paying off the loan.
In agriculture, inventory credit works a little different. The produce that is used for the loan has to be stored in a reliable and bonded warehouse by a third party. In agriculture, inventory credit is used for imported produce, produce ready to be exported, and domestic products. The warehouse owner that stores the produce has to ensure that it remains in good condition and is secure. The agricultural company that borrows the money is charged a fee for the storage of the produce and to insure it against damage. This inventory credit process is used widely in Africa and parts of Asia
When Should You Use Inventory Credit?
Inventory credit is not a practical means of financing for every business. It largely depends on the type of industry you are in as well as the current state of the economy. Businesses that should not use inventory credit are those will a low turnover rate for their inventory. This means that if your inventory sits there for a long time and cash flow from it is slow, you would be better off finding an alternative means of financing. Otherwise, you may have a difficult time paying back the loan. This is also true for inventory that is out of date, expired, or obsolete.
Businesses that would benefit from an inventory credit loan would be those who have a high turnover rate for their inventory. If business is good and your company is moving a lot of inventory product but you still need more money in order to keep up with demand, then you should check out an inventory credit loan.