Banking - Inventory Collateral
Essential reading for business owners. Retired financial executive explains how the banker views your business loan application, and collateral, so you know how to present it. One of a series of articles to help business owners succeed in understanding how to optimize their financing and keep their banker happy!
This segment will explain the essentials of how a bank evaluates the inventory that is offered as collateral for a business loan or an operating line of credit. As explained in the segment on equity, this is not supposed to be a text book course, but explains briefly what you will encounter in the real world of business finance.
These comments are not for the retail business; they apply to wholesalers, importers and manufacturers.
The amount of money the financial institution will be prepared to lend you will depend a great deal on the amount and ease of realization of the inventory collateral you can offer to cover the loan, in case there is a default in repayment.
It is not just the amount of the collateral, but the quality of the collateral, and whether it would realize enough to repay the loan if there was a liquidation of the business.
A typical example might be that your main collateral for a $1 million loan application is your inventory of widgets. The widgets will cost you $1,250,000 and you expect to sell them for a total of $2,000,000 which would gain you a $750,000 profit.
You would think your bank would be pleased to approve the loan.
These are some evaluation techniques related to the inventory that the bank will utilize before the credit approval decision can be made:
It is unusual for a bank to finance more than fifty percent of the cost value of inventory, because of the risks involved.
However, if you are an importer and you require the bank to open letters of credit for your suppliers, the bank may provide higher financing if you can show that a substantial portion of the inventory being bought is against customers’ purchase orders. Your borrowings, as shown in your cashflow projections, should also be within the line of credit approved for your business. Always keep in mind, when making your credit application, that bankers hate surprises! Give them all the information they need to make a credit decision upfront. If there is any negative aspect, bring it up and explain how you plan to deal with it.
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ABOUT THE AUTHOR
Roshmi Raychaudhuri & Jay Chatterjee launched their web site http://www.youngagainforever.com to promote natural health information and remedies. Roshmi, a businesswoman, is based in India. Jay, a retired CA and ex-commercial finance executive, resides in Canada. Topics in their website include anti-aging yoga exercises, vision, teeth, weight-loss, hair-loss, meditation, hypnosis, finance. Financial health is important for a stress-free life.