Warehouse Financing Explained – Definition & Key Benefits

Financing is one of the most important requirements for any business. Sustaining business operations, let alone expansion and growth, can become very challenging without a steady stream of capital.

While new businesses can always opt for start up loans in India, what about established entities? Warehouse financing is one of the myriad forms of financing available for such businesses.

Wondering what warehouse financing is and how it can be beneficial to a business? Here’s a comprehensive guide that can help you understand what it is.

What is Warehouse Financing?

Warehouse financing is a specialised form of lending that’s designed for businesses manufacturing goods or dealing with inventory. In this type of financing arrangement, businesses pledge their inventory held within a warehouse as collateral with a bank or a financial institution to avail of short-term loans. Since inventory is used to avail of a loan, warehouse financing is also referred to as inventory financing.

Warehouse funding enables businesses to get access to capital without effectively liquidating their inventory. Since a lien is created on the inventory, businesses cannot sell or use it in any manner until the borrowed amount is repaid along with interest. Once the repayment is complete, the lien over the pledged inventory is removed and borrowers may sell the inventory to its customers.

Understanding Warehouse Financing

Let’s now try to understand the concept of warehouse funding more thoroughly with the help of a hypothetical scenario.

Assume you run a business that deals in a wide range of electronic goods. You currently have an inventory that’s worth roughly ₹25 lakhs in a dedicated warehouse. Due to certain unexpected circumstances, you run into liquidity issues and lack the funds required to service a business loan obligation.

Since missing a business loan EMI can negatively impact your credit score and history, you plan to use warehouse financing to cover this financial obligation. You reach out to a bank that is willing to offer a loan against the inventory you hold in your warehouse.

A warehouse financing agreement is entered into where you avail of a loan of ₹5 lakhs by pledging ₹10 lakhs worth of your inventory as collateral. The interest rate on the loan is 2% per month. You use the loan of ₹5 lakhs to successfully cover your loan obligation.

You then sell the remaining ₹15 lakhs worth of inventory over the next two months and use the funds to repay the borrowed loan along with interest, which comes up to ₹5.20 lakhs [₹5 lakhs + (₹5 lakhs * 2% * 2 months)].

With warehouse financing, there are a few points you should note. Since inventory tends to depreciate over time, the amount of loan offered by the lender will generally be lower than the value of the goods being pledged as collateral. Lenders usually offer anywhere from 50% to 80% of the inventory value as a loan.

Also, depending on the warehouse funding agreement you enter into with the lender, the inventory pledged as collateral is either moved to a separate warehouse managed by a third party or is segregated from the rest of your inventory in your own warehouse using a fence or a barrier to restrict unauthorised access.

If you don’t repay the loan on time within the stipulated due date, the lender is well within their rights to sell the pledged inventory in the open market to recover the unpaid loan amount. However, if you successfully repay the loan along with interest on or before the due date, the pledged inventory is returned to your possession and control.

Importance of Warehouse Financing

• This form of financing is essential for businesses as it enables importers to secure funding based on the value of their inventory. This provides them with the necessary working capital to maintain seamless operational efficiency.
• With this type of funding, businesses can benefit from longer payback terms and lower interest rates compared to other financing methods such as unsecured loans or credit lines.
• It allows businesses to retain custody of their products while safely storing them in a warehouse facility until the inventory is needed or sold.

The Benefits of Warehouse Financing

Warehouse financing offers a plethora of advantages for businesses dealing with inventory. Let’s look at some of the key benefits of this financing option. 

• Immediate Liquidity

By pledging their inventory as collateral, businesses can get quick access to capital without having to liquidate them or resort to lengthy business loan approval processes. Compared to other traditional loan options, warehouse financing is much faster with low turnaround times. 

• Flexibility 

Another major benefit of warehouse funding is its flexibility. Businesses have the freedom to choose the loan amount and repayment terms that suit their specific requirements and cash flow patterns. 

• Efficient Working Capital Management 

Stagnant inventory is one of the many factors that cause gaps in the cash flow of a business. Warehouse financing enables businesses to address this particular issue by converting unsold or stagnant inventory into cash, which can then be used to cover various operational expenses. With proper timing, businesses can optimise their cash flow and streamline their operations.

Also Read: Working Capital Management – Importance and Meaning

• Expansion Opportunities
  

By providing quick access to capital, warehouse financing empowers businesses to leverage growth and expansion opportunities as and when they present themselves. Be it product line expansion, investing or upgrading infrastructure or entering new markets, businesses can quickly seize all opportunities without the fear of a funding crunch.

• Risk Mitigation
  

Unforeseen market fluctuations and economic downturns can have a significant negative impact on the value of the products, especially those that are price-sensitive. However, with warehouse financing, businesses can mitigate the various risks that arise due to such unexpected fluctuations by securing funding against their tangible inventory before downturns and market fluctuations reduce their value.

Eligibility for Warehouse Loans

The eligibility criteria you must meet to avail of the warehouse financing facility will vary depending on the lending institution you opt for. Here’s a look at some of the general factors that lenders often look for in businesses seeking inventory financing. 

• Established Track Record
  

Banks and other financial institutions often prefer businesses that are established and have a stable customer base and robust inventory management practices since it makes selling the pledged inventory a lot easier for the lenders in case of non-repayment of the loan. 

• Creditworthiness
  

The credit score and history are the other major factor that lenders may look for in businesses. A long credit history with timely repayments and a high credit score is often viewed very positively when granting warehouse financing.  

• Inventory Quality
  

The quality of the inventory being pledged, their value and their marketability (demand) are also crucial factors that determine your eligibility. Businesses with high-quality inventory that have a strong demand in the market are more likely to be eligible for this financial arrangement. 

• Repayment Capacity
  

The financial standing of your business and the ability to meet the loan obligations are also factored in when determining your eligibility. Lenders often examine your financial statements and Income Tax Returns (ITRs) to get an idea of the cash flows, profitability and overall financial health of your business.

Documents Required for Warehouse Loans

Similar to the eligibility criteria, the documents that you need to submit as part of a warehouse financing application will vary depending on the lending institution you opt for. Here’s a quick look at some of the documentary evidence you may be asked to submit.

• A copy of your identity proof
• A copy of your address proof
• A copy of your business proof
• A copy of the latest financial statements and Income Tax Returns of your business
• A copy of the business plan clearly outlining the purpose of the loan and growth strategies
• A copy of the details of the inventory being pledged including the quantity, market value, description and marketability assessment
• Proof of insurance for the inventory being pledged as collateral

Warehouse Financing Vs. Warehouse Lending

• Warehouse financing is a short-term financing option where businesses use their inventory as collateral. This helps in financing inventory and is repaid once the inventory is sold.
• Warehouse lending, on the other hand, is a long-term financial arrangement used by mortgage lenders. Here, the mortgage loans are secured through a warehouse loan scheme, and repayment is made once the mortgage loans are sold to investors.
• The primary distinction lies in the type of collateral used. Warehouse financing is secured by physical inventory whereas warehouse lending is backed by mortgage loans.

Warehouse Financing Vs. Traditional Bank Loans

• Collateral: Unlike traditional bank loans, which accept a variety of assets as collateral, this form of financing specifically uses inventory or goods as security.

• Risk Assessment: Traditional bank loans rely heavily on the borrower’s creditworthiness, financial history, and business plans. In contrast, lenders of this financing assess the quality and quantity of the collateral (inventory).

• Loan Amount: The amount in warehouse financing is typically capped to the value of the inventory acting as collateral. Traditional loans may exceed the collateral’s value if the borrower demonstrates strong creditworthiness.

How to Choose the Right Warehouse Financing Option?

• Evaluate Your Inventory: Assess the value, turnover, and market demand for your inventory. This will guide the amount you can borrow under a warehouse loan scheme and help identify the best fit for your financial requirements.

• Understand the Costs: Review associated costs, including interest rates and fees, and weigh them against the benefits of using collaterals for financing.

• Consult with Experts: Seek advice from financial consultants experienced in warehouse financing to make well-informed decisions tailored to your business.

Structuring Your Warehouse Financing:

• Loan Agreement: Carefully review the terms, including repayment schedules and penalties, ensuring they align with your financial capacity.

• Collateral Management: Establish clear procedures for managing and valuing your inventory collateral.

• Repayment Plan: Design a repayment structure that aligns with your cash flow and operational needs to maintain financial stability.

This approach ensures businesses can leverage this form of financing effectively while managing their resources efficiently.

Conclusion

For businesses dealing with large inventories, warehouse financing can serve as an important lifeline that can be used to gain access to working capital and optimise cash flows. However, if you’re planning to opt for warehouse financing, it is advisable to compare multiple offers from different lenders. This way, you can make informed financial decisions that are in line with the needs and requirements of your business. Lendingkart’s warehouse finance solutions cater to storage needs, offering ₹50,000 to ₹2 crores with 1-36 month terms. Fast, online, collateral-free applications, competitive interest rates, and flexible repayment options make these loans ideal for optimising warehouse operations.

1. What is warehouse financing?

Warehouse financing is a form of lending where a bank or a financial institution offers short-term loans to a business against its inventory. Here, the products that the business manufactures are pledged as collateral to secure the loan.

2. What is warehousing in finance?

Warehousing is a term used to refer to the act of storing manufactured goods in a designated safe space or location before they’re sold or distributed to sellers. Warehouse financing leverages this concept by enabling businesses to avail of short-term loans by pledging their warehoused goods as collateral.

3. What is the interest rate for a warehouse loan?

The interest rate on a warehouse loan can vary depending on factors such as the inventory being used as collateral, the borrower’s creditworthiness, prevailing market rates and the terms of the loan agreement.

4. What is field warehousing financing?

Field warehousing financing is a variation of warehouse financing. Here, the lender separates the pledged inventory from the rest of the business’s inventory using a fence or a barrier. This enables the lender to tightly control the access to the pledged inventory, thereby mitigating risks.

By carefully evaluating these factors, lenders in India can determine the risk associated with a loan and implement appropriate risk mitigation strategies. This ensures a healthy financial ecosystem that fosters economic growth and empowers individuals and businesses to achieve their financial goals. Revolutionizing finance for Indian MSME, Lendingkart offers a powerful duo: Lendingkart 2Gthr, a leading online lending marketplace, and Lendingkart Xlr8, a platform designed to fast-track warehouse financing. Together, they provide the financial tools businesses need to thrive.