Distribution finance is a revolving credit structure that lets a distributor borrow against the inventory sitting in the warehouse and the invoices customers haven’t paid yet. Instead of waiting 60 or 90 days for a customer check, or locking cash into stock, you draw on a line secured by those same assets. The balance rises when you buy inventory and falls when customers pay, so the loan effectively breathes with the business. It is one of the few financing structures where the operating cycle itself is the repayment mechanism.
That self-liquidating rhythm is the core engine. Inventory sells and converts into a receivable. The receivable collects, and the cash flows to the lender, paying the line down. Paying it down frees up capacity for the next inventory purchase. There are no lump-sum repayments to schedule; the sales activity does the work.
How the Borrowing Base Controls What You Can Draw
Every facility runs off a borrowing base, the formula that sets your ceiling at any given moment. The lender assigns advance rates to each category of eligible collateral. According to OCC guidance, advance rates on accounts receivable typically range from 70 to 85 percent, with some lenders going as high as 90 percent for strong business-to-business receivables. Inventory advance rates run up to about 65 percent of book value, or 80 percent of an appraised net orderly liquidation value, which is what the inventory would bring in a quick but organized sale.1OCC.gov. Asset-Based Lending – Comptrollers Handbook
A simple example. You have $500,000 in eligible receivables and $300,000 in eligible inventory. The lender sets an 80 percent advance on receivables and 60 percent on inventory. Your borrowing base is $580,000. You can draw up to that ceiling, and the ceiling adjusts daily as you sell, invoice, and collect.
The word “eligible” carries most of the weight. Invoices older than 90 days past due are almost always excluded. Concentration limits typically cap any single customer at around 20 to 25 percent of the receivables pool, so if one buyer represents too large a share, the excess simply does not count. Cross-aging is the rule that catches distributors off guard: if a certain percentage of one customer’s invoices are past due, commonly 25 to 33 percent over 90 days, the lender can disqualify every invoice from that customer, not just the late ones. A single slow account can shrink your borrowing base overnight.
The Three Types of Distribution Finance
Distribution finance breaks into three products, each targeting a different stage of the cash conversion cycle. Which one fits depends on where your cash gets stuck: in warehouse stock, in unpaid invoices, or in the gap between what you owe suppliers and what your customers owe you.
Inventory and Floorplan Financing
Inventory financing provides capital to purchase and hold physical goods. When those goods are high-value serialized items such as vehicles, heavy equipment, or electronics, the arrangement is usually called floorplan financing. The lender pays your supplier directly and takes a lien on the specific items, often tracked by serial number.
Control is tight. Lenders use electronic tracking or unannounced field audits to verify that every financed item still sits on your lot. When you sell a financed item, you notify the lender and remit the corresponding principal immediately. The OCC describes curtailment schedules where, if an item hasn’t sold within a set period (commonly 90 days), you start making partial principal payments, often around 10 percent of the original loan balance per month, to protect the lender against the inventory becoming obsolete or losing value.2OCC.gov. Floor Plan Lending – Comptrollers Handbook
Some manufacturer-backed programs offer an interest-free window, sometimes called “free floor,” during the first 30 to 90 days after the inventory ships. It functions as a subsidy from the manufacturer to encourage distributors to carry more stock. Once the free period expires, interest accrues at the contractual rate until the item sells or hits its curtailment deadline.
Accounts Receivable Financing
Once you have sold the goods, you typically wait 30 to 90 days for the customer to pay. Accounts receivable financing closes that gap through two structures.
Factoring is an outright sale of your invoices to a finance company. You receive an advance of 75 to 90 percent of the invoice face value, and the factor collects directly from your customer. The remainder, minus the factor’s fee, comes to you after collection. Fees generally run between 1 and 5 percent of the invoice value, driven by customer credit, payment terms, and volume. In recourse factoring, you bear the risk if the customer does not pay. In non-recourse factoring, the factor absorbs the credit risk on approved accounts.
A revolving AR line of credit works differently. You keep ownership of the invoices and handle collections yourself; the receivables serve as collateral for a revolving loan. The cost is an interest rate (often a spread over a benchmark like SOFR or prime) plus administrative and monitoring fees, rather than a per-invoice factoring fee. This tends to be cheaper for businesses with high invoice volume and reliable customers, but it demands stronger internal bookkeeping since you are still running collections.
Supply Chain Finance
Supply chain finance, also called reverse factoring, flips the model. Instead of financing what your customers owe you, it addresses what you owe your suppliers. A third-party financier, usually a bank, pays your supplier early at a small discount. You then repay the financier on extended terms, often 90 to 120 days later.
The advantage is that the financing cost is priced off your credit profile, not your supplier’s. If you are a large distributor with a strong balance sheet, the discount rate reflects your lower borrowing cost, which makes early payment attractive to suppliers who would otherwise wait or borrow at higher rates themselves. Your vendors get paid faster while you extend your own payment cycle. The arrangement works best for distributors with enough purchasing power and creditworthiness that a bank will underwrite the program.
What Distribution Finance Costs
Cost varies by product, collateral quality, and credit profile. There is no single rate because the pricing components differ across structures.
For revolving lines secured by inventory or receivables, expect an interest rate (a spread over a benchmark) plus fees for collateral monitoring, field audits, and borrowing base management. Audit fees alone can run several thousand dollars per examination, and lenders may conduct two to four per year. There is usually an unused line fee, a small percentage charged on the portion of the facility you do not draw, compensating the lender for reserving the capacity.
Factoring is priced as a discount on the receivable itself, typically 1 to 5 percent of the invoice. Longer customer terms and weaker debtor credit push the fee higher. For high-volume portfolios with strong debtors and short terms, rates can dip below 1 percent.
Floorplan financing carries an interest rate on outstanding principal, curtailment penalties if inventory ages past its scheduled turn date, and audit fees. Manufacturer subsidies during promotional periods can significantly reduce the effective rate.
Across all structures, plan for closing costs: legal documentation, UCC filing fees, inventory appraisals, and possibly an origination or commitment fee. These fixed expenses mean distribution finance pays off when there is enough borrowing volume to absorb them.
The UCC Framework Behind the Loan
Distribution finance sits on a legal foundation defined almost entirely by Article 9 of the Uniform Commercial Code. The UCC governs how a lender creates, records, and enforces its claim on your collateral, and the rules are unforgiving if any step is missed.
The security agreement is the contract that grants the lender a legal interest in specific collateral: inventory, accounts receivable, equipment, and sometimes broader categories of business assets. Under Article 9, the security interest attaches, meaning it becomes enforceable, only when three conditions are met: the lender has given value (advanced funds), you have rights in the collateral, and you have signed a security agreement that describes the collateral.3Legal Information Institute. Uniform Commercial Code 9-102 – Definitions and Index of Definitions
Attachment alone does not protect the lender against competing creditors. To establish priority, the right to be paid first if things go wrong, the lender must “perfect” its interest. For most distribution finance collateral, perfection requires filing a UCC-1 financing statement with the state filing office, usually the Secretary of State. The filing creates a public record that puts other creditors on notice.4Legal Information Institute. Uniform Commercial Code 9-310 – When Filing Required to Perfect Security Interest or Agricultural Lien
There are exceptions. For collateral governed by other statutes, such as motor vehicles titled under a certificate of title system, a UCC filing alone will not do the job. The lender must comply with the applicable title statute instead.5Legal Information Institute. Uniform Commercial Code 9-311 – Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties This matters for distributors in the auto, marine, or heavy equipment space, where certificate-of-title laws override standard UCC filing. A UCC-1 remains effective for five years; the lender keeps the lien alive by filing a continuation statement within the six months before it expires.6HUD Exchange. Uniform Commercial Code (UCC) Filings
Life Inside the Facility
A distribution finance facility is not a set-it-and-forget-it loan. Once you sign, you are subject to ongoing covenants and reporting obligations that the lender monitors closely. Falling out of compliance, even technically, can restrict your borrowing or accelerate the whole facility.
Covenants
Lenders tailor covenants to your operations and collateral. Common ones include an inventory turnover ratio, a minimum debt service coverage ratio, a minimum tangible net worth requirement, and a maximum leverage ratio. Slow inventory turnover is a particular red flag because it signals potential obsolescence, which erodes the collateral’s liquidation value.
Borrowing Base Certificates
You submit a borrowing base certificate on a regular schedule, often daily or weekly. The document calculates your available credit based on eligible receivables and inventory at that moment, and the lender uses it to approve or restrict draws in near-real time. Accuracy matters. Submitting an inflated certificate is not just a breach of the agreement; it is the kind of misrepresentation that can turn a commercial dispute into a fraud allegation.
Field Audits
Expect the lender or a third-party firm it hires to appear at your warehouse periodically to physically count inventory, inspect its condition, and reconcile what they see against what you reported. For receivables, auditors verify that key customers exist, confirm that high-value invoices are legitimate, and check that no disputes or offsets would reduce the amounts owed. Audits happen multiple times a year, sometimes without advance notice, and the distributor typically pays the cost.
Lockbox and Cash Dominion
Most asset-based lenders require a lockbox arrangement, where customers send payments to a bank-controlled account rather than to you. In a full dominion setup, the bank applies those collections to your loan balance before releasing any remaining funds. In a springing dominion arrangement, cash passes through to you normally, but the bank reserves the right to seize control if you breach any term.1OCC.gov. Asset-Based Lending – Comptrollers Handbook Either way, the lender has a direct pipeline to your incoming cash. It is the mechanism that makes distribution finance self-liquidating, and it is one of the biggest operational adjustments for distributors used to controlling their own collections.
What Default Looks Like
Default in a distribution finance facility carries consequences that go well beyond a late fee. The lender’s remedies under the UCC are broad and can move quickly.
After default, a secured party can pursue any available judicial remedy: sue for the amount owed, foreclose on the collateral, or take possession of the collateral and sell it.7Legal Information Institute. Uniform Commercial Code 9-601 – Rights After Default; Judicial Enforcement; Consignor or Buyer of Accounts, Chattel Paper, Payment Intangibles, or Promissory Notes These remedies are cumulative, so the lender can pursue all of them at once. In practical terms, the lender can sweep your lockbox account, seize warehouse inventory, and file suit for any deficiency simultaneously.
Most distribution finance agreements include acceleration clauses. A default on one covenant can trigger immediate repayment of the entire outstanding balance, not just the portion tied to the breach. Cross-default provisions may also connect the facility to other loans, so a default here can cascade elsewhere.
The most dangerous scenario in floorplan financing is “selling out of trust,” which means selling financed inventory and failing to remit the proceeds. Because the lender has a security interest in each specific item, selling that item and keeping the cash is treated as a form of fraud in most jurisdictions. Beyond civil liability, it can result in criminal charges. This is where distribution finance differs most starkly from a conventional loan: the collateral is individually tracked, and every sale triggers a specific repayment obligation. There is no grace period and no ambiguity about whose money it is once the item sells. In bankruptcy, debts arising from selling out of trust are frequently pursued through adversary proceedings, and courts may rule the debt non-dischargeable.
Qualifying for a Facility
Lenders underwrite distribution finance on both financial health and collateral quality. In many cases, the collateral analysis matters more than the balance sheet. A distributor with thin margins but fast-turning, highly marketable inventory may qualify more easily than a profitable company sitting on slow-moving specialty goods.
On the financial side, lenders want a track record, typically two to three years of operating history with consistent revenue. They dig into gross margin trends, operating expenses, and cash flow to confirm you can cover debt service. Strong internal controls are essential because you are responsible for producing accurate borrowing base certificates and inventory reports on a tight schedule. If the lender cannot trust your data, the facility does not work.
For receivables, lenders look at the creditworthiness of your customers, the aging of your portfolio, concentration risk, and payment patterns. A diverse customer base where no single buyer accounts for more than 20 to 25 percent of receivables is ideal. High concentration, slow payment, or significant disputed invoices will shrink your borrowing base or disqualify you.
For inventory, the question is simple: how quickly and reliably could this be sold in a liquidation? Standardized, brand-name goods with active secondary markets get the highest advance rates. Highly customized, perishable, or rapidly depreciating inventory gets low advance rates or is excluded. The lender evaluates historical sales velocity, seasonal demand, and obsolescence risk before assigning a value.1OCC.gov. Asset-Based Lending – Comptrollers Handbook
The underwriting package is substantial:
- Inventory schedules showing quantities, locations, costs, and aging for all stock on hand.
- AR aging reports breaking outstanding invoices out by days past due, customer, and dollar amount.
- Historical sales data, revenue broken out by customer and product line, typically two to three years.
- Audited or reviewed financial statements covering income, balance sheet, and cash flow.
- Organizational documents, including operating agreements, corporate formation records, and proof of authority to borrow.
- Forward-looking projections for 12 to 24 months showing anticipated revenue growth and repayment capacity.
Distribution finance rewards distributors who can operate inside its discipline: accurate reporting, tight inventory control, and a customer base the lender is comfortable relying on. When those pieces are in place, the facility funds growth in a way conventional term loans cannot, because it scales with the business as the business actually moves.