You receive a large order from a business customer. Under your standard payment terms, they have 30 days after delivery to pay you. To fulfil the order, you need to buy stock upfront, but your suppliers want payment now and your cash is already committed to rent, wages and other running costs.
One way to bridge the gap is inventory financing: funding secured against your stock, which lets you pay your suppliers now and repay the lender once your customer pays you. A merchant cash advance (MCA) is another option, assessed on your sales record instead. Learn how inventory financing works and how businesses in Australia can fund their inventory purchases. Explore inventory funding alternatives, and how businesses can evaluate whether a stock purchase is worth financing.
What is inventory financing?
Inventory financing is a form of business funding used to purchase stock a business intends to sell. Businesses use inventory financing to supplement cash flow, as suppliers often need to be paid before the stock generates revenue. Funding these purchases can help businesses maintain stock levels without tying up all their available cash until the goods are sold.
Traditionally, inventory financing takes the form of an inventory loan or line of credit, with the stock serving as security for the funding. An inventory loan provides a lump sum to purchase stock, while an inventory line of credit lets a business draw funds up to an agreed limit as needed.
|
Inventory loan |
Inventory line of credit |
| How it works |
The business receives a lump sum to purchase inventory. |
The business receives access to a set credit limit and draws funds as needed to purchase inventory. |
| How funding is accessed |
Usually provided upfront as a single amount. |
Funds can be accessed in stages, up to the approved limit, subject to the facility's terms. |
| How funding is repaid |
The business repays the amount borrowed, plus interest and any applicable fees, according to an agreed schedule. |
The business repays the amount drawn, plus interest and any applicable fees. Repaid amounts may become available to draw again, depending on the facility's terms. |
| Best suited for |
A specific, planned stock purchase, such as a bulk order or seasonal inventory purchase. |
Ongoing or recurring inventory needs, such as regularly replenishing stock or managing fluctuations in demand. |
| Key consideration |
The business needs to estimate how much funding it requires and ensure it can meet the repayments. |
The business needs to manage its borrowing carefully and understand any credit limits, withdrawal conditions and ongoing fees. |
Inventory financing is one of several ways that businesses finance inventory, which simply means paying for stock before it sells. You could use your own cash, negotiate payment terms with your supplier, or opt for alternative funding, such as a merchant cash advance (MCA). The type of funding that suits your business needs depends on how much cash you have, how quickly the stock will sell and what each option costs.
When do SMEs need to finance inventory?
SMEs may need to finance inventory for several reasons, including:
- Cash flow mismatch: The business must pay for stock before sales revenue arrives.
- Working capital constraints: Available cash is insufficient to cover inventory and other operating expenses simultaneously.
- Inventory requirements change: The business needs to buy more stock, earlier than usual, or in larger quantities to meet demand or secure supplier terms.
In Australia, SMEs may need to finance inventory at different stages of their business, whether to maintain stock levels, respond to changing customer demand or prepare for growth. Common situations include:
- Restocking fast-selling products: Businesses need to reorder popular items before existing stock runs out. If suppliers have long lead times, placing orders early helps prevent stock shortages and lost sales, but it also means committing cash before the replacement stock starts generating revenue.
- Fulfilling a large customer order: A business may need to purchase additional goods, raw materials or components to meet an order. If the supplier requires payment before delivery and the customer pays later, the business must cover the upfront cost while waiting for the revenue to come in.
- Launching a new product line or menu: Introducing new products or dishes can require an upfront investment in merchandise, ingredients and packaging. The business must fund these purchases before it knows how quickly the new offerings will sell, leaving cash tied up in stock while demand develops.
- Preparing for a busy period: Retailers and hospitality businesses may need to build up inventory before peak trading periods, when customer demand is expected to increase. This requires spending ahead of anticipated sales, potentially putting pressure on cash flow before the busy period begins.
- Buying in bulk: Suppliers may offer discounts for larger orders or regular purchases, allowing businesses to reduce the cost per unit. However, bulk buying requires more cash upfront and can leave money tied up in inventory for longer, particularly if the stock takes time to sell.
What these have in common is a timing gap between paying for stock and earning from it. It is a short-term funding need: the money is needed now, and it comes back as the stock sells.
How traditional inventory financing works
Traditional inventory financing depends on what the stock is worth to the lender. The steps vary between lenders, but they generally follow two stages: the lender assesses you, then the funding runs its course.
What lenders look at
- The stock: Because the stock serves as security, the lender assesses its value and how easily it could be sold to recover the money if the business defaults. Factors may include the stock’s type, condition, market demand and how quickly it typically sells.
- The business's finances: The lender may review financial statements to assess profitability, cash flow and ability to repay.
- Credit history: Weight varies by lender, and some lend to businesses with less-than-perfect credit.
- Security: Also commonly referred to as collateral, which is the underlying asset used to back the loan. In this case, it is usually the stock itself, though lenders may request additional security depending on the funding amount.
What happens next
- The lender sets the financing amount: The amount offered may depend on the stock’s assessed value, not its original purchase cost. Lenders may advance only a percentage of that value, so the business might need to cover the remaining cost itself.
- The funding is provided under an agreed facility: Depending on the arrangement, the business may receive a lump-sum loan or access to a revolving line of credit. The lender sets the applicable repayment terms and security requirements.
- The business repays the funding: The business must meet the agreed repayments even if the stock takes longer than expected to sell. It should therefore estimate how quickly the stock is likely to generate revenue, and whether cash flow will be enough to cover repayments.
- The lender may be able to seize and sell the stock if the business defaults: Because the stock secures the funding, the lender may be able to repossess and sell it if the business defaults, subject to the funding agreement and the Personal Property Securities Act 2009 (Cth). SMEs should understand these risks before committing.
Documents and information lenders may require:
- Inventory records: Detailed stock lists showing product types, stock keeping units (SKUs), quantities, and current condition.
- Inventory valuation: Independent valuations or documentation estimating the current market value of the stock.
- Sales records: Trading data demonstrating sales turnover, aged receivables, and inventory turnover rates.
- Financial records: Recent financial statements (Profit & Loss, Balance Sheet), cash flow forecasts, and recent business bank statements.
- Business documents: Australian Business Number (ABN/ACN) details, company structures, and director identification.
- Proposed security: Details of the assets available to back the loan, which the lender will use to draft the formal security agreements and PPSR registrations upon approval.
How an MCA can finance inventory purchases
Inventory financing is only one way that businesses can pay for stock. The right route depends on how much you need, how quickly you need it, what it costs and what you can offer as security.
1. Drawing from cash reserves
Drawing from cash reserves means paying for stock with money your business has already set aside. It carries no interest or fees, but it ties up money you may need for rent, wages and other running costs, and it leaves less of a buffer if sales are slower than expected.
2. Supplier credit
Some suppliers let you pay after delivery, on payment terms such as 14 or 30 days. While it can be the cheapest option when it is available, suppliers may not offer it to new customers or for large orders, and paying late can strain the relationship.
3. Merchant cash advance (MCA)
A merchant cash advance (MCA) gives a business funding upfront, which it repays with a fixed fee agreed in advance, usually from a percentage of its future sales. Strictly, it is not inventory financing, because the stock you buy does not usually secure it. It's another way for business owners to pay for inventory purchases.
How to check if a purchase is worth funding
A purchase is worth funding only if the profit from selling the stock exceeds what the funding and holding the stock will cost you. Four checks show whether it does.
Step 1: Add up your total costs
Total costs are the stock cost plus the funding cost plus your holding costs.
- Stock cost: What you pay your supplier.
- Funding cost: The interest and fees on a loan or line of credit, or the fixed fee on a merchant cash advance. Use the total you will repay, not a headline rate.
- Holding costs: What it costs you to keep the stock until it sells, such as storage, insurance and the risk that some of it spoils, goes out of date or doesn’t sell. Add any other costs of selling it, such as payment fees.
Step 2: Estimate your sales revenue
Work out how much you would earn if all the stock sold. Use a conservative figure, based on what you have sold before, since demand is uncertain. If you expect to sell some of it at a discount, lower the estimate.
Step 3: Calculate your break-even sell-through
Break-even sell-through is the share of the stock you need to sell to cover all your costs.
Break-even sell-through = total costs ÷ expected sales revenue if all the stock sells
The lower the percentage, the more of the stock can go unsold before you make a loss. If it is close to 100%, almost everything has to sell at the price you expected for you to break even.
Step 4: Check the timing
Compare how long the stock will take to sell with how long you have to repay the funding. Repayments continue even if the stock sells slowly, so a purchase that breaks even on paper can still strain your cash flow if it sells too late.
Choosing how to finance your inventory
Paying for stock before it sells is a short-term funding need. Inventory financing, cash reserves, supplier credit and a merchant cash advance can each meet it, with different costs and repayment terms. Whichever you choose, check first that the profit from selling the stock comfortably exceeds the funding cost and the cost of holding it.
