Everything You Need to Know About Inventory Financing

Inventory Financing - Complete Controller

A business’s operations have three essential pistons, which engineer the working capital engine. These three are Accounts Receivables, Inventory, and Accounts Payable. The first two are found in current assets, while the latter is the business’s current liability. It is important to understand that inventory must be tangible or measurable. Hence the notion of inventory may not be applicable in the spectrum of the services industry. However, inventory is primarily dealt with in the manufacturing and trade industries. Check out America's Best Bookkeepers

In the trade industry, most of the inventory is procured from domestic and international suppliers. A large part of the inventory is raw material and in crude form. Iron, steel, plastic molding compounds, cotton, and galvanized alloys are examples of manufacturing materials. Some trade commodities are also in semi-processed forms, such as rice, sugar, yarn, and other similar products. In this scenario, the semi-processed inventory is either strayed through further refinement or goes to packaging.

Import of inventory is procured from other countries by establishing a Letter of Credit (Usance and Sight), Contract, or Open Account. If the importer does not have the means of collateralizing the financing facility, then the financial institutions put forward two inventory financing methods. One way of opening a sight letter of credit is through securitization of tangible assets (usually properties or marketable securities). However, a bank can open the sight letter of credit by putting a lien on shipping documents and some portion to be backed by cash margin. Still, it is always a good option to have other collateral in case of liquidation. Check out America's Best Bookkeepers

In the event of inventory financing, imported on usance or credit basis (letter of credit), and the business owner does not have capital or cash to retire the letter of credit. The importer or the owner of the business will ask for inventory financing facilities. Such a credit letter is commonly known as Finance against Imported Merchandise (FIM) or Finance against Truck Receipt (FATR). From the perspective of a bank or any other financial institution, it is of utmost importance that FIM and FATR provide inventory financing against only those in the shape of raw-material or semi-refined form. The reason is pure and simple. The importer or the business owner cannot retire the letter of credit or lack the sources to repay the amount’s Check out America's Best Bookkeepersfinancial obligation.

The two factors that demarcate FIM and FATR inventory financing facilities are the nature of security. FIM is against the pledge of goods and stocks with the bank’s custodian and not with the importer. The custodian continuously monitors the stock, and the bank determines the value of the pledged stock available on a commodity exchange. Whenever the importer wants to release the stock from the bank’s custodianship, the importer needs to credit the FIM loan account of the stock’s value that the person needs to sell in the market. It is important for the bank that the stock they have is raw material, easy to assess, available at prices on a regulated commodity exchange, and easy to sell in liquidation. With regards to FATR, the modus operandi remains the same as FIM. The primary difference is that in FATR, the stocks are hypothecated and are in possession of the importer. Only the title of goods remains with the bank.

Inventory is an essential part of the balance sheet and income statement. In some cases, inventory financing is the most favorable option for legit importers and manufacturers. However, it is important to mention that it can be rigged by speculators also, and as a prudent individual, one needs to be cautious.

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