Inventory purchases Featured

8:00pm EDT October 26, 2008

Companies that control their inventory levels and maintain careful tracking systems will present a stronger case to the bank when seeking funds. In these times, banks have tightened their lending procedures. Bankers must feel confident that the loans they grant for inventory purchases will be paid back in a timely fashion.

“Businesses that are heavily laden with inventory need to provide great detail to the bank in terms of what type of inventory they carry, how much is warehoused and how fast inventory is turned,” says Craig Johnson, president and CEO, Franklin Bank, Southfield, Mich.

Smart Business spoke with Johnson to learn how companies can position themselves to obtain loans to fund inventory purchases.

What type of inventory is a ‘safe bet’ from the bank’s perspective?

One of the first questions a banker will ask is whether inventory is raw materials, finished products or ‘work-in-process’ inventory. Raw materials include steel, nuts, bolts and other parts that manufacturers need to build a product; these and finished products are much easier for a bank to liquidate. (Banks must consider this worst-case scenario when evaluating a company’s inventory.) Raw materials are a commodity, and there is a ready market for discounted finished goods. However, banks consider work-in-process inventory a riskier investment. Say your company purchases partly complete widgets from a supplier. Your facility puts the finishing touches on the widget to make it a finished product. The problem is, in the event of liquidation, the bank generally is not in a position to ‘finish the process.’

The bank must be quite certain that your company is sound and inventory controls are in place to ensure that ‘in-process’ goods are completed, shipped and paid for. The paperwork and inventory histories you provide will build a banker’s confidence if your company purchases work-in-process inventory.

What paperwork should a company provide to describe its inventory to the bank?

If you have multiple facilities where inventory is warehoused, show records of how much inventory is contained in each location. Prove that you perform regular inventory checkups to verify that your paper records correspond with your physical inventory. Track and document any time inventory is moved, shipped, received or fluctuates in any way. Who are your suppliers? List each vendor, and also keep on record the customers who purchase/use your product. The bank will also ask to see a record of inventory turns, sales histories and company financials.

How are inventory loans generally structured?

Typically, the bank will grant the loan as part of an overall line of credit, which typically involves an advance formula against accounts receivables. There may also be an advance formula as part of the overall inventory. In many cases, the inventory advance is a fixed dollar amount and a set inventory level is named. For example, for a $5 million line of credit, the bank may lend $1 million against the inventory value at a 50 percent advance with a minimum inventory level of $2 million. The remainder of the credit line ($4 million) might be advanced at 75 percent of billed accounts receivables with aging of under 90 days.

What red flags alert a bank that a company is not managing its inventory properly?

If auditors make large inventory adjustments at year-end, that’s a red flag that you are not properly maintaining inventory during the course of the year. Be sure to conduct periodic inventory checks. If your turns are inconsistent with similar companies in the industry, the banker will want to know why. Perhaps you have obsolete or slow-moving inventory on hand. Finally, the bank does not want to see continuously building inventory levels and stagnant or lower sales. This reflects low inventory turns and also indicates that there is slow-moving or obsolete inventory in the warehouse. Most banks will not want to grant a loan if a company already has a warehouse stocked full of goods that the business isn’t collecting on.

What can a company do to remove the financial burden of slow-moving inventory?

The bank wants to see that you are working hard to sell or ‘move’ inventory. If items are slow-moving or obsolete, they should be discounted and turned over quickly. Offer salespeople incentive and higher commissions to move those products. Focus on clearing out that inventory, even if you sell goods for less than you paid for materials. If inventory is stagnant and sitting on shelves, the best thing you can do is take a loss, return cash to the company and move on.

CRAIG JOHNSON is president and CEO of Franklin Bank, Southfield, Mich. Reach him at CLJohnson@franklinbank.com or (248) 358-6459.