How Inventory Financing Works in Canada

How Inventory Financing Works in Canada

Startup owners and entrepreneurs whose businesses entail selling products need to know how inventory financing works in Canada. This is to enable them to access more loan financing for their goods.

Lenders are sometimes hesitant to approve funds for new and small businesses because they need a quick return on capital. If you fall into this category, your best bet is getting inventory financing.

The guide will talk extensively about how inventory financing works in Canada, the different types of inventory financing and management, other sources of financing your business, and the pros and cons of inventory financing.

What is inventory financing?

Inventory financing can be defined as a short loan or line of credit  (LOC) that a business can access to buy inventory. This type of financing is used by businesses that deal with large inventories.

It’s crucial that traders and entrepreneurs know how inventory financing works to access loans easily. Businesses in these categories include restaurants, hotels, supermarkets, retailers, and wholesalers.

Businesses can know how much they need by checking their inventory turnover rates. An inventory turnover rate is the ratio by which a business buys and replenishes its stock over a given period. When a business owner understands this rate, they will be able to keep their stocks intact.

Moreover, with inventory financing, you can purchase stocks ahead of time, especially during high-volume periods. Inventory financing differs from personal loans in that it doesn’t need a guarantor or collateral aside from the inventory.

You will be better prepared for busier periods of sales later in the year. This helps prevent any delay for your customer.

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How does inventory financing work?

Inventory financing works by accessing a type of credit or loan that a business uses to buy products. When you understand how inventory financing works, obtaining capital for your business will be smooth.

Any inventory that you buy becomes collateral for the loan. The lender is safeguarded from potential loss in this scenario. If there is a default, the lender seizes the goods to recoup the debt.

Here’s how it works in detail:

  • The lender pays for your goods
  • The supplier sends you the products and you stock your inventory
  • You sell the goods and pay back the lender.
  • Depending on the type of lender used, you could be able to apply for loans around $400,000–$1,000,000.

The repayment period is usually determined by how long the products are on the market.

What are the types of inventory financing available?

There are a few terms of financing agreements that can be used to secure an inventory loan, though all of them require collateral. Here are the Types of inventory financing available in Canada:

Inventory Loans

Inventory loans are short-term loans that allow business owners to buy and sell quickly. With this type of inventory financing, business owners in Canada will have to make a large upfront capital investment and pay both the principal and interest in installments.

With most lenders in Canada, the minimum loan amounts are high. The smallest loans could be around $400,00 (these vary with lenders).

The amount you will get will be a percentage of your appraised inventory value. For example, lenders may provide 75% of the amount needed, or $525,000, to finance the acquisition of inventory with a liquidation value of $700,000. 

An Inventory loan is an excellent choice for entrepreneurs who deal in large stocks. With a clear picture of how inventory financing works, business owners in Canada will buy stocks in bulk and enjoy discounts.

Inventory Lines of Credit

Another common inventory financing type is lines of credit. This is more suitable for businesses that need access to funds for inventory purchases. When a company owner gets a line of credit, the amount of money they receive is determined by the worth of their inventory. These loans will be paid immediately after the inventory is sold.

With this loan, you will only pay interest on the money withdrawn and other extra fees. Due to inconsistent cash flow, it is crucial to have access to an Inventory line of Credit in order to effectively manage stock on hand.

Nonetheless, remember that negotiating with your suppliers is required prior to approaching an inventory financing lender about a line of credit.

Benefits of inventory financing

Here are the pros of inventory financing in Canada:

Self-collateralized

With Inventory loans, you don’t need any collateral. This is because they are secured by the purchase inventory, which means the lender can take back the merchandise if there is a default.

This makes it an excellent choice for small businesses in Canada that don’t have assets to offer as collateral. You may be lucky with some lenders, though, because some provide insecure inventory loans. What this means is that even if you default, you can still keep your goods.

Helps Meet Customer Demand

Inventory financing is similar to working capital loans in that it helps businesses meet customer demands and keep stocks filled. This is a great way for people involved in e-commerce and bulk business to survive in this cash-crunched economy.

This type of loan helps businesses buy lump sums of inventory without risking their capital.

Solves Cash Flow Issues

Inventory financing can help address the cash flow problems that most customers face. You can manage your cash flow better because you don’t have to pay for goods upfront. With this type of financing, businesses have more flexibility when buying inventory, which helps them purchase goods when prices are low.

Simple Application

When compared to other types of business loans, applying for inventory financing is much simpler. This makes it quicker for business owners to access funds without problems.

Cons of inventory financing

Here are some drawbacks associated with inventory financing:

Limited Financing

Businesses that need a huge lump of capital might not find this type of loan favourable. This is because most lenders in Canada offer around 70–80% of the value of the inventory purchases. This implies that you will still need to source about 20–30% of the capital needed.

Inventory Fluctuations

Sometimes, a business faces inventory instability due to the unpredictable nature of the markets. Sometimes sales expectations aren’t met, and there is an unusual drop in demand. This can affect cash flow and make repayment of loans difficult.

High-Interest Rates

The interest rates and fees attached to Inventory financing loans are a bit higher. Traditional loans offer better interest rates and charges; however, with Inventory financing loans, they are high. The reason is that lenders are taking more risks by offering funds for goods not sold.

Categories of businesses that should consider inventory financing

As an entrepreneur, seeking funds to replenish your stocks might be a problem. If you are short on money to make purchases for your inventory, then you should consider inventory financing. This financing is a great solution for businesses like:

  • Distributors
  • Wholesalers
  • Manufacturers
  • Retailers

The above business needs to get its stock filled regularly.

Factors considered for inventory financing

Although every lender has different conditions to consider before approving this loan, many Canadian lenders will only approve inventory financing if:

  • Most of your profits come from selling products to commercial customers
  • You have a reliable inventory monitoring system
  • You can provide them with up-to-date, accurate financial statements
  • You deal in products that are easily marketable (FMCG)

The above conditions are just some of the factors considered; you will have to ask your lender what they require for you to be eligible.

Tips to help compare inventory financing loans

When comparing inventory financing loans, here are some useful tips:

Assess Qualification Requirements

Most lenders in Canada require you to have been in business for at least a year (some 6 months) before approving this finance loan. Many also consider credit, the record of loan repayments, and available collateral. Lenders in the country vary in their requirements.

Consider Repayment Options

How you repay inventory financing loans varies from one lender to another. It’s important to always consider lenders with more flexible repayment plans. Some lenders to consider include:

  • Merchant Growth
  • ICapital
  • Loans Canada
  • 2M7 Financial Solutions
  • Greenbox Capital

They offer affordable inventory financing with easy repayment options.

Understand Collateral Requirements

Many lenders need different forms of collateral for inventory. You will need to understand how inventory financing works, what types of collateral are needed by vendors, and how it affects loan agreements.

How to improve your chances of getting an inventory financing loan

Here are some steps that can help increase the odds of getting you that inventory financing from your lender:

  • Regularly check your credit report for fraud-related errors
  • Pay off any outstanding debts
  • Always maintain a good credit score (Canada business score range: 0-100)
  • Leverage your inventory or other useful collateral
  • Find a trustworthy person to co-sign your application

Documents required to apply for inventory financing

If you want to apply for an inventory financing loan in Canada, here are some documents you might need to provide:

Business and Personal Tax Returns

Most lenders will ask you to provide your business and personal tax returns. Your business will need to be adequately structured and smoothly run to avoid problems. Most lenders in Canada will ask for Tax returns for at least two years.

Business and Personal Bank Statements

An inventory financing lender may want to examine which assets you have and what cash balance you have in the bank. This is done to track the movement of funds from and into your account. Most lenders in Canada will ask for statements for at least three to four months.

Present Inventory List

Entrepreneurs should also be prepared to present the list of inventory to a lender. Aside from the list, you may also be asked to show where it is stored and what security is provided to keep these goods safe. If you are familiar with the inventory’s estimated liquidation value, you should tender that too.

Inventory Management System Details

A Canadian Lender will also want to track your stocks. Therefore, you will need to show records that include the following:

  • The rate of inventory turnover
  • The amount of inventory you are unable to sell
  • How much profit you make in your last transactions
  • This will help them determine if your business is viable or not.

Balance Sheet

Most Canadian finance firms might ask for your balance sheet for the year.

This balance sheet shows liabilities, assets, and cash at hand. This is meant to show how financially prudent you are and if you can manage a business.

Profit and Loss Statement

Along with the balance sheet, you may also need to provide an accurate profit and loss statement. Financing firms might also ask you to review your profit and loss statement for two years.

Sales Forecast

Lenders in Canada will also look at what your future sales forecast looks like. They will need an original and updated sales forecast to determine if your application will be granted.

Factors that determine the interest rates in inventory financing

Now that you have a better understanding of inventory financing, here are some factors that dictate the interest rates on this loan:

Resale Value of Product

The lender will consider the real value of the inventory before setting an interest rate. Because the inventory is the collateral for this loan, they consider if the item will move easily in the market and at what price.

Perishability

The perishable nature of the goods is also another crucial factor that determines the interest rate of the loan. Some lenders avoid goods that have a short lifespan to avoid spoilage.

This is particularly important for those in the Pharmaceutical and FMCG markets. Goods that have a longer shelf life have a better interest rate than those with short term.

Logistics Considerations

Since not all goods are transit-friendly, lenders are wary of goods that can be easily damaged during movement. Goods such as glasses, paints, and other thin-fabric materials come with higher interest rates.

Once the lender sees that the product is difficult to sell once it is damaged, it is considered a liability.

Appreciation/Depreciation

Another factor to consider is how the value of the inventory appreciates and depreciates. Some products are very unstable when it comes to prices; therefore, most lenders are wary of approving loans for them.

Sales and Performance History

Your record of sales will also be considered when interest rates are considered. If you have a great sales record, lenders will give you a lower Interest rate. However, if you have a below-par sales history, you could get a high interest rate on your inventory financing loan.

Alternative ways to finance inventory

Aside from inventory, here are some other ways to get loans for your inventory:

Vendor Financing

With this method, the vendor lends funds to the borrower so he can fill his inventory. The borrower can then buy items on credit without providing any collateral. It’s important to note that most vendors collect interest on deferred payments based on an agreement with the borrower.

Crowdfunding

With the Crowdfunding method, a group of people in the same line of business contribute to buying products. This is done by people who don’t have enough funds to buy bulk goods, thereby looking for partners to buy products and share based on the amount contributed.

Accounts Receivable and Inventory Financing (ARIF)

Account Receivable financing is a loan based on unpaid business invoices. If your business has a lot of invoices and capital tied up, you may leverage your assets to secure loans. With AR financing, you only get 70–80% of the value of unsold invoices.

Purchase Order Financing

Purchase Order financing is an ideal way for startups and e-commerce businesses to finance their inventory. In this type of inventory financing, you pay an advance fee to purchase the stocks you need. This PO financing is a great choice for businesses that deal in finished goods and need to refill their orders quickly.

Invoice factoring and purchase order financing are both forms of debt financing. In this case, however, the order itself is being financed rather than the business itself. For invoice factoring, you are taking loans for a completed order.

Final thoughts about how inventory financing works in Canada

Entrepreneurs who want to succeed need to understand how inventory financing works in Canada. We have explained in detail how inventory financing in Canada works and how businesses can take advantage of it. This is a nice monetary method to get your business working without delay.

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FAQs about how inventory financing works in Canada

How does inventory finance work?

Inventory financing is a loan offered to small and large businesses to pay for products which aren't meant for immediate sale. In this type of loan, financing is collateralized by the inventory meant for purchase. It's usually considered by entrepreneurs who don't have access to other loan options.

What is the formula for inventory financing costs?

To determine the formula for inventory financing cost, you will need to add expenses such as capital, labour, storage, taxes, administrative, transportation, and insurance. You will also need to add shrinkage, depreciation, and Obsolescence. After the sum has been arrived at, you will then divide the cost by the aggregate inventory value and multiply by 100.

What are the features of inventory financing?

Inventory financing is a collateral-based loan option, which means that in the event of a default, the lender retrieves the goods. It is a type of financing option that medium and large businesses in Canada obtain to keep their stocks from depleting.

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July 17, 2023
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