If a small business goes to a bank for a loan to finance their working capital and the bank says no, the business doesn’t have to give up. If the business produces products and has inventory, it can use inventory financing to raise money. Inventory financing is more expensive to the business than a bank loan. However, inventory financing can be used to supplement working capital needs, including cash needed for import export financing.
Blanket Inventory Lien
One form of inventory financing is the blanket inventory lien. A blanket inventory lien is a loan secured by the firm’s inventory. The inventory is, in effect, the collateral for the loan. This type of loan allows businesses to keep large amounts of expensive inventory on hand. The business could not afford to keep this inventory on hand on its own. The only way it can afford to have the inventory selection for its customers is to utilize this type of inventory financing.
Examples of firms that may use blanket inventory liens are those who sell inventory that is high priced and doesn’t use move very quickly, such as luxury items.
Floor planning, also called trust receipts, is another form of inventory financing where the loan is secured by using the firm’s inventory as collateral. It is a little different and more secure than the blanket inventory lien. Under floor planning, a lender loans the money for the inventory and the small business holds the inventory in trust for the bank. When the inventory is sold, the firm pays off the lender and keeps any profit. This type of inventory financing is a way that small businesses can afford to display a reasonable amount of merchandise.
An example of both a blanket inventory lien and floor planning might be a small specialty car dealership selling only one brand of vehicle such as the Jeep. The owner may find Jeeps that are in excellent condition and make improvements on them before resale. However, each vehicle is expensive and the only way the owner of the business can afford to carry this inventory is to take out either a blanket inventory lien or participate in floor planning, depending on their particular situation.
Field warehousing is the most secure type of inventory financing for the lender. Usually, a bank is involved in a field warehousing arrangement. The inventory of the small business is actually kept in a warehouse secured by the lender or a third party hired by the lender. When some of the inventory is sold by the small business, it is released from the warehouse and the lender is given a receipt and payment for the inventory. It is in this way that the inventory serves as collateral for the loan and the lender receives payment.
The portion of the firm’s inventory actually used for collateral is segregated from the remainder of the firm’s inventory. Because of all the parties involved in this type of financing, it is very expensive and should be used when other forms of financing are exhausted.
Understanding inventory financing is important for two reasons. First, small business owners need to be prepared to use one of these methods of inventory financing if necessary. Second, owners need to know they have options if banks say no to traditional bank loans or other financing arrangements.