Inventory Financing for Importers


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TEFO Home About TEFO Management Team Products & Services Trade Glossary Import Finance Tutorial Export Finance Tutorial	Inventory Financing for Importers Introduction Importer/Distributors commonly need to maintain a complete stock of inventory to supply North American buyers as required. But large stock levels can easily tie up significant amounts of working capital. One way to maximize the amount of financing available for inventory is to seek a commercial finance company that specializes in Asset-Based Inventory financing. Inventory financing, as a part of broader Asset-Based Lending (ABL), is an important source of financing in the United States . This category of asset-based financing accounts for about one- third of total U.S. commercial and industrial loans. This form of financing is currently only significant in two other countries, Canada and the United Kingdom . To be feasible, asset-based inventory lending requires well-defined commercial law that clearly specifies security interests, an efficient lien registration system that clearly defines when liens are filed, and an efficient bankruptcy system that preserves lender priority and minimizes time in bankruptcy. As opposed to a traditional bank line of credit, which may take Inventory as backup collateral, asset based inventory lenders considers inventory to be the primary source of repayment. The amount of credit extended under an asset-based inventory loan is explicitly linked to a formula based upon the type of inventory collateral and how quickly it can be sold. This link is continuously monitored to ensure that the value of the inventory always exceeds the amount of the loan. A key benefit of asset-based inventory lending is that the common high leverage of Importer/Distributors is not necessarily a barrier to finance if the company's underlying inventory assets have sufficient liquidation value. Thus, asset-based inventory lending is well suited to highly leveraged Importer/Distributors. Many Asset Based lenders will include inventory financing as a lesser component of a line of credit that primarily provides advances against the Accounts Receivable. Since the liquidity of Inventory is lower than Accounts Receivable, most all Asset Based lenders advance a relatively low amount against qualified inventory. The TEFO Network includes the small group of North American lenders that specialize in inventory financing. These lenders serve a variety of industries including Importer/Distributors. Lenders that specialize in inventory financing work closely with their clients to develop expertise in their client's business processes and the type of inventory. This hands-on approach enables the specialist to provide a much higher percentage amount of financing against inventory than standard bank or ABL loans. Example Soleria Inc. is an importer and distributor of innovative solar roof tiles. Solaria has worked with the Australian manufacturer for over two years and has established good terms of purchase for the solar roof tiles. Terms of 30 days acceptance have been negotiated whereby the manufacturer ships the product and sends the shipping documents through bank channels. Solaria is obligated to sign a 30 day trade acceptance draft (a promissory note) in order for the Bank to release the shipping and title documents. In 30 days, Solaria pays the bank for the solar roof tiles and the funds are be remitted back to the manufacturer in Australia . After 6 months of intense marketing Solaria received a large order from a major regional roofing contractor for $325,000 in product every 3 months. This good news was accompanied by some bad news. Solaria's finances could not handle this new business. A cash flow analysis showed that there was a major gap in income and outgo. The problem stemmed from the need for Solaria to maintain 48 days of inventory in stock at all times to accommodate incoming orders. Since Solaria had to pay the Australian supplier in 30 days there was a disconnect. The Manufacturer was sympathetic but had their own problems and could not help. Solaria's Bank advised that they could not help with anything more than their minimal working capital line of credit. With the specter of lost business opportunity, Solaria called TEFO. The TEFO team reviewed the deal, conducted due diligence and brought in a specialized inventory finance partners. Our finance company recognized Solaria potential and was quite keen on participating in an alternative energy project. After reviewing Solaria's business processes, they did recommend new inventory controls which Solaria quickly adopted. The new inventory line of credit saved the new business opportunity by enabling the payment of the manufacturer in 30 days and enabled Solaria to maintain their 48 days of inventory turnover. Features Revolving inventory loan facilities is a form of inventory financing for working capital needs. Under a "Revolver" credit is s ecured by a security interest in all existing and future inventory Under a Revolver advances are made based upon a specified percentage of the value of the borrower's eligible inventory Credit lines normally have a one year maturity Credit lines c ommitments range from $100,000 on up "Purchase-money financing" is an alternate form of inventory financing "Purchase-money financing" is where a lender loans funds to enable the purchaser to acquire specific goods and receives a security interest in the specific goods. "Floor-planning" is a common form of inventory financing where a lender makes loans to finance the acquisition of a borrower's stock of inventory. "Floor-planning facilities are often provided to dealers of vehicles, computers and large consumer appliances. Warehouse Receipts Financing is a method of inventory financing is for businesses that carry large inventories composed of finished goods or raw materials with a good disposal market. With Warehouse Receipts Financing inventories are placed in a bonded warehouse as security for loans of up to 80 percent of their value. As a business draws inventory from the warehouse, the loan is paid down the amount drawn. Prerequisites For businesses with good credit and sales history. Lenders must feel is secure with the inventory collateral. May require computerized Perpetual Inventory System for maintaining status information on company inventory. May require reliable, timely financial and inventory reporting May require reporting to lender the status of your inventory including aging, costs, etc. May require Weekly/Daily Collateral Reports May require efficient and planned inventory purchasing May require strong inventory control and inventory maintenance systems May require demonstration of purchase orders to indicate inventory will not age. May require personal guaranties of company principals May require financial covenants Advantages To Importer Offers importer increased credit availability based on security in financed inventory. Allows distributors and resellers to stock inventory with extended payment terms Improves importer/distributor's working capital position Enables company to accept larger orders that would otherwise have been passed up. Enables increased purchasing power to take advantage of volume discounts Can facilitate expanded sales and increased profits Frees up cash that is currently tied-up in existing inventories to make more Supports seasonal demands for increased inventory. Repayment schedules can be structured to accommodate seasonal cash flows Disadvantages To Importer Financing not available for obsolete or hard-to-sell merchandise. Is not available for companies with very slow turnover of inventory Lender may require additional collateral, such as equipment or property. Must have the ability to produce reliable, timely financial and inventory reporting Lender may require right to regularly inspect financed inventory Lender may require inventory to be audited or appraised by independent third parties. Credit line minimum amounts may be too high for some importer/distributors Determining Inventory Advance Rates Lenders evaluate inventory, as they do receivables, in order to establish advance rates. Advance rates on inventory are usually lower than those on receivables because inventory is less liquid. Outstanding accounts need only be collected; goods in inventory must be finished, sold, and paid for. An additional risk factor in lending against inventory is the potential of a priority claim by the supplier of the inventory goods. In some industries and states the seller of the inventory may have an automatic prior lien (known as a purchase money security interest) on that inventory even if there is no UCC filing. Advance rates on inventory generally range between 20 percent and 65 percent. When establishing inventory Loan-To-Value rates, lenders often limit risk by using the liquidation value rather than the higher market value of the inventory pledged. Lenders strive to build in a sufficient margin to protect against price risk and marketing and administrative costs. To establish the value of various types of inventory, lenders often rely on expert appraisals or evaluations and their experience liquidating similar types of inventory. Inventory advance rates vary depending on the inventory's product type and state, i.e., raw materials, work-in-process, or finished goods. Finished goods and commodity-like raw materials usually receive the highest advance rates because they are easiest to sell. Advance rates for some finished products such as fungible goods or goods with established markets are normally of greater value than specialized or perishable goods (unless such goods are adequately insured). As for raw materials, commodity items such as iron ore used by a steel maker are much easier to resell than customized items such as specialty pigments used to manufacture paint. Customized component parts may have only nominal resale value. Work-in-process is frequently excluded from the collateral used to determine the borrowing base because it has limited liquidation value since it requires additional production cost to be converted to salable merchandise. Determining Eligible Inventory Collateral Only salable inventory is considered eligible collateral. Some inventory is excluded from collateral because of age or some other measure of obsolescence. Lenders pay particular attention to borrowers in fashion-sensitive industries to ensure that obsolete inventory is written off in a timely manner. Eligibility may also be limited because of the location of the goods. Inventory stored in multiple locations may be assigned a lower advance rate because it is more difficult to monitor and control and often is more costly to liquidate. Consignment goods are normally considered ineligible because they, too, are more difficult to control. Lenders assess the reasonableness of advance rates by comparing such rates over time and review trends in similar industries. Procedure Make application to TEFO Provide TEFO with basic financial package Provide an up-to-date business plan that shows your business is growing Demonstrate ability to make loan payments. What to Watch Out For High interest rates or other fees. An ambiguous definition of what constitutes eligible Inventory can lead to problems Some lenders will require borrower to pay off the line of credit for up to one month a year If inventory turnover slows borrower may be forced to unload your inventory at a loss to pay down line of credit. Lenders may require strict inventory control Cost Cost of financing is based on the following factors: Amount of credit required - the higher the credit, the lower the cost Inventory turnover - the faster it sells, the lower the cost Type of inventory - the greater the collateral strength, the lower the cost Fees range from 2% to 6% over Prime or Libor rate. Copyright © 2004, 2005 Ted S. Eastman. None of the contents of this article may be reproduced or republished without the express permission of the author		We take your privacy and the security of your company's information very seriously. Please view our privacy and security policy.
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