What it means
Businesses that hold a lot of stock, such as commodity traders, wholesalers and manufacturers, often have cash tied up in goods that cannot yet be sold. Warehouse financing releases part of that cash by letting them borrow against the stock while it sits in storage.
To make the security reliable, the lender usually wants control over the goods. The stock may be held in a third-party warehouse that issues receipts, or in the borrower's own site under the supervision of a collateral manager who checks quantities and releases goods only when the lender agrees.
The lender will not advance the full value. It applies an advance rate (the percentage of value it will lend), usually well below 100% to allow for price falls, damage or slow sales, and the rate is lower for perishable or fast-obsolescing items.
Costs include interest, arrangement fees, storage and inspection charges, and the cost of insurance. The borrower should compare the total with the profit earned by holding and selling the stock, because the financing can be expensive for slow-moving goods.
A simple test is whether the gross margin on the stock comfortably exceeds the financing cost over the time the goods are likely to remain unsold. In mortgage and consumer lending the phrase has a related meaning.
A warehouse line is a short-term facility from a bank that lets a loan originator fund new loans, hold them for a few weeks and then repay the line when the loans are sold to investors. The main risks are fraud, quality problems and price movements.
Lenders therefore inspect the goods, monitor prices and require regular reporting, and borrowers should expect to receive requests for top-up security if prices fall.
In practice
Real-world examples.
Example
A coffee importer buys beans in bulk and stores them in a bonded warehouse while waiting for roasters to place orders. A bank lends 70% of the value of the beans, and the importer repays as each lot is sold.
Example
A furniture manufacturer builds up stock before a seasonal peak and needs cash to pay suppliers. A lender advances funds against the finished goods, supervised by a collateral manager who checks the warehouse each month.
Example
A mortgage lender uses a warehouse line from a bank to fund new home loans. It repays the line within a few weeks, when the loans are packaged and sold to investors, and then draws again for the next batch.
Formula
Calculation
Loan amount = value of stored goods x advance rate
Interest cost = loan amount x annual interest rate x (months borrowed / 12)
Suppose a wholesaler holds $500,000 of stock in a warehouse and the lender offers a 70% advance rate. The loan is 500,000 x 0.70 = $350,000. If the annual interest rate is 9% and the loan is outstanding for 4 months, the interest cost is 350,000 x 0.09 x 4 / 12 = $10,500. The wholesaler receives $350,000 of working capital against stock that would otherwise be idle, at a cost of $10,500, and must fund the remaining $150,000 itself.Case study
Seen in the real world.
Pinecrest Timber is an illustrative, fictional supplier of building timber. It bought a large shipment ahead of the construction season, spending $900,000, and found that its overdraft was almost fully used.
The finance manager arranged warehouse financing with a lender that advanced 65% of the value of the stock, which amounted to $585,000. A third-party warehouse issued receipts and the lender released goods in batches as invoices were paid.
The loan cost $19,000 in interest and fees over five months, while the early purchase saved much more in lower prices. The illustrative lesson is that this form of financing works best when the goods are easy to value and sell, and when the margin on the goods is wide enough to cover the cost.
Watch out
Common mistakes.
- Assuming the lender will advance the full value of the goods, when advance rates are usually well below 100%.
- Ignoring the full cost, including storage, inspection, insurance and arrangement fees as well as the interest.
- Using the financing for slow-moving or obsolete stock, where falling value can trigger demands for extra security.
Questions
People also ask.
How is warehouse financing different from an ordinary inventory loan?
The lender takes closer control of the goods, often through a third-party warehouse or a collateral manager, which gives it greater confidence in the security.
What happens if the price of the stored goods falls?
The lender may reduce the loan or ask the borrower to add cash or other security, because the value of the collateral has dropped.
Who pays for the storage?
Normally the borrower, as part of the cost of holding the goods, and the cost should be included when comparing financing options.
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