Types of Inventory Financing
Basic raw material and finished goods inventories represent reasonably liquid assets and are therefore suitable as security for short-term loans.
There are several ways in which a lender can obtain a secured interest in inventories: floating lien, chattel mortgage, trust receipt, terminal warehouse receipt, and field warehouse receipt.
In the first three methods, the inventory remains in the borrower’s possession, and the last two methods, the inventory is in the possession of a third party.
Table of Contents
A floating lien involves pledging inventories “in general” without specifying the specific property involved. Under this arrangement, the lender obtains a floating lien on the borrower’s inventory.
The lien allows for the legal seizure of the pledged assets in case of loan default. The floating lien is loose, and the lender may find it difficult to police. Commercial banks often require floating liens as extra security on what would otherwise be an unsecured loan.
With a chattel mortgage, inventories are identified by serial number or some other means. While the borrower holds title to the goods, the lender has a lien on inventory. This inventory cannot be sold unless the lender consents.
Because of the rigorous identification requirements, chattel mortgages are ill-suited for inventory with a rapid turnover of inventory that is not easy to identify specifically.
However, Chattel mortgages are well suited for certain finished goods inventories of capital goods such as machine tools.
Under a trust receipt arrangement, the borrower holds the inventory and the proceeds from its sale in trust for the lender.
This type of lending, also known as floor planning, has been used extensively by automobile, equipment, and consumer durable goods dealers.
Inventory in the trust is specifically identified by serial number or other means. The borrower is allowed to sell the inventories but must turn the proceeds of the sale over to the lender in payment of the loan.
The lending company periodically audits the inventories to see whether the borrower has sold inventories without remitting the proceeds of the sale to the lender.
Terminal Warehouse Receipt
A borrower secures a terminal warehouse receipt loan by storing inventory with a public or terminal warehousing company.
The warehouse company issues a warehouse receipt, which evidences the title to specific goods that are located in the warehouse. The warehouse receipt gives the lender a security interest in the goods, against which a loan can be made to the borrower.
Under such an arrangement, the warehouse can release the collateral to the borrower only when authorized to do so by the lender. The terminal warehouse receipt can be either non-negotiable or negotiable.
Field Warehouse Receipt
The pledged inventory is located on the borrower’s premises in a field warehouse receipt loan. Under this arrangement, a field warehousing company reserves a designated area on the borrower’s premises for the inventory pledged as collateral.
The field warehousing company has sole access to this area and is supposed to maintain strict control over it. The field warehouse company issues a warehouse receipt, and the lender extends a loan based on the collateral value of the inventory.
A field warehouse receipt is appropriate when a borrower frequently uses inventory.