Loan or Advance against Inventory

Definition

Distributor Finance is a form of Loan or Advance based Supply Chain Finance is financing provided to a buyer or seller involved in a supply chain for the holding or warehousing of goods (either pre-sold, un-sold, or hedged) and over which the finance provider usually takes a security interest or assignment of rights and exercises a measure of control.

Also denoted as Inventory Finance, Warehouse Finance, Financing against Warehouse Receipts, Floor Plan Finance.

Business Model Description

In this business model Loans or Advances against Inventory may be used at any stage and by any party in a supply chain acting as seller and/or a buyer. The incidence of the financing need will depend on the structure and timing of the manufacturing and delivery cycles deployed along a particular supply chain.

Inventory financing is typically confined to qualifying marketable commodities (e.g. raw materials such as minerals, metals and agricultural products) for which a value can be readily ascertained, and to finished goods or work in progress where a potential buyer may have already been identified and for which a contract to purchase or a purchase order may have already been issued; the requirement to identify a buyer or have a contract or purchase order in place recognises the potential lack of marketability of finished goods or work in progress.

The financing is usually arranged as a loan or advance against the inventory, although variations described below provide alternatives. The tenor of transactions will be short term and advances are usually made under a committed or uncommitted facility with an annual review.

For the financing of finished goods and work in progress, reference is made to the definition of Pre-Shipment Finance. The finance of goods in transit such as on-board a vessel or by air may also be included.

For some market participants, loans against inventory in the setting of SCF necessarily involve a seller and a buyer in a structured relationship as part of a particular supply chain.

The borrower and finance provider enter into a financing agreement and a security agreement covering title to the underlying inventory and covering warehouse receipts (evidencing storage of the goods in the warehouse) where used. Ancillary agreements with a warehouse operator and third party collateral management or inspection agents may also be required.

Value Proposition

The main benefit of this form of SCF is the ability of the client to obtain funding based on the security of easily realisable assets and bridging the working capital gap between the point of procurement and the achievement of sales.

For the finance provider it provides a short term business opportunity based on an expected source of repayment and readily realisable security.

Distribution Channels

Distribution Channels are the means by which a company communicates with and reaches its Customer Segments to deliver its Value Proposition.

Customer Relationships

A typical Loan or Advance against Inventory transaction involves two main parties: the client or borrower (which could be a seller or buyer, as noted earlier) and the finance provider.

A third party warehouse may also be involved, which could be certified or recognised by governmental or trade bodies, and in which the existence and condition of stored inventory is continuously monitored by a reputable third party and/or by the finance provider itself.

The goods may also be stored in a location under the direct control of the finance provider or on the borrower’s own premises.

Revenue Streams

• Fees
• Security Margin

Key Resources

• Personnel
• IT Systems

Key Activities

Procedures are required for

• the disbursement and repayment of the financing;
• the perfection of the security interest through the assignment of rights;
• the possession and control over the inventory being financed;
• the continuous monitoring of the condition and value of the inventory; and
• the calculation of margin and borrowing base as applicable.

If the value of the inventory has been hedged in the futures market this also requires continuous monitoring.

Risk Management

The risk management section focuses on the risks that must be managed by the business model. The risks to the business model itself can be identified with the Business Model Risk identification framework

• Difficulties experienced by the customer in disposing of the inventory in a timely fashion under a third party sale in order to generate repayment or an inability to refinance the inventory
• Quality or damage to the inventory mitigated by inspections and property and casualty insurance
• Ongoing business risks impacting the ability to repay
• An ability to re-possess and dispose of the relevant inventory in the event of the borrower becoming illiquid or insolvent. Having and retaining the necessary industry and product experience is a key risk for the finance provider
• The location of the inventory, for example, stored within an independent warehouse, or if on the borrower’s premises stored in a way that the goods can be easily identified and carefully controlled
• The intrinsic value and saleability of the inventory remains a continuing risk factor during the life of the transaction and this is influenced by the condition of the inventory, its importance to a critical manufacturing or sales process, market conditions, and logistics aspects in the event of the need to exercise the right to repossess and sell
• It is common to advance only a percentage of the value of the inventory so as to establish a margin of protection. For a situation where a number of lines of inventory are financed, a ‘borrowing base’ may be established whereby an ongoing collateral pool is established against which a maximum advance is computed
• Credit analytics is applied to the borrower in the normal way to ensure on-going viability and cash generation ability especially by means of a firm take-out by means of sale to a reputable buyer, and to establish that dependence on realising security is minimised
• There is a risk of the borrower double-pledging the same inventory. This can only be mitigated by the financing provider’s due diligence and, where relevant, a good choice of warehouse provider with adequate controls

Key Partnerships

Partnerships is the network of suppliers and partners that help make the business model work:

• Platform providers (B2B networks, e-invoicing solutions, software vendors)
• Bank or Non-Bank Funders providing funding for SCF programmes
• Credit Insurers
• Other risk management partners (FX/IR hedging)

Cost Structure

• Personnel Salaries
• Infrastructure Costs

Competitors

• Alternative Supply Chain Providers
• Alternative Forms of Financing