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 [email protected] or
(248) 358-6459.
