Inventories though not really considered as liquid asset are also being used as collaterals to obtain short term loan from lenders.
From the lender’s standpoint, in the event of borrower’s default, the lenders can still dispose off the inventories at book value ( assuming those inventories items are easily marketable with stable pricing)
The quantum of borrowing depends on the marketability and the conditions (perishable) of the inventory.
Several methods of using inventory to secure short-term loans:
1. Floating Lien Agreement
· Borrower gives lender a lien or claim against all its inventories
· However, the control of the inventories is fully with the borrower
· Not so popular to the lenders as the control of the inventory are not in their hands
· Inventories comprises diversified group of relatively inexpensive merchandise.
· Quantum of borrowing amount therefore is lower like 50% of the book value of the average inventory
2. Chattel Mortgage Agreement
· Inventory is identified in the agreement
· Borrower retain title to the inventory but cannot sell the items without lender’s consent
· Often made against relatively inexpensive automotive, consumer durable and industrial goods that can be identified by serial number
· Quantum of borrowing amount about 80 % to 100% of the book value of the average inventory.
3 Field Warehouse-financing Agreement
· Inventories which are collaterized are physically separated from the firm’s other inventories and placed under the control of a third-party field warehousing form.
· Quantum of borrowing about 75% to 90% of the book value of the average inventory.
· Note that there will be additional costs like security guards to supervise the inventories in the warehouse.
4. Terminal Warehouse Agreement
· Except that the inventories being collaterized are transported to a public warehouse.