Line of credit or term loan for seasonal inventory

Match the term of the money to the life of the thing it buys. That rule answers the question in most cases, and it is worth understanding why rather than just following it.

Inventory is self-liquidating; a term loan is not

Seasonal stock has a defined life. You buy it, you sell it, and within one cycle it is cash again. A revolving line has the same shape: draw when you buy, repay when you sell, sit near zero in between, pay for what you used.

A term loan disburses once and amortises on a fixed schedule regardless of what the goods did. After the season, when the inventory has become cash, the loan is still taking payments — and when the next buying season arrives it cannot be redrawn. So the retailer refinances, or takes a second facility, and carries permanent debt created by a temporary need.

Where the argument for a term loan is actually reasonable

Three situations genuinely favour term debt:

• You cannot get a line. A revolver needs more history, better financials or acceptable collateral. If the only committed money available is a term loan, take it and plan the exit rather than pretending the mismatch is not there.
• The stock is not seasonal. A permanent step-change in inventory — a second location, a category you will always carry — is a lasting increase in working capital, and financing part of it on term is defensible.
• You are refinancing something worse. Converting a daily-repayment advance into an amortising term loan usually improves your cash position even though it lengthens the debt.

The clean-down clause, and why it exists

Many revolving lines require the drawn balance to reach zero, or near it, for a set number of consecutive days each year. That is the lender testing whether the line is working capital or term debt in disguise. It is a reasonable test, and you should plan for it.

Check when your clean-down window falls. If the line requires thirty consecutive days at zero and you only hold surplus cash in one month, you have a covenant that is easy to breach and easy to schedule around, depending entirely on whether you noticed it.

What to work out before you choose

On a revolving line at 12%, carrying that balance for five months costs $4,000 a year. Over four seasons, $16,000 — and the facility is available again every August.

On a five-year term loan at 10%, the payment is $1,699.76 and total interest over the full term is $21,985.81. You are still paying in July, when the stock became cash six months earlier. You are still paying the July after that. And in the August after you drew it, the balance is $67,018.55 and none of it can be redrawn, so the next buy needs $80,000 from somewhere else.

The term loan has the lower stated rate and costs more. The rate is not the reason. You rented the money for sixty months to finance something that lived for five.

The figures are chosen to show the mechanics; run it on your own cycle and your own quotes.

Two seasons in a row, and the ratchet

The problem is rarely visible in year one. It shows up in year two.

Carry the illustrative figures forward. The term loan funded August's buy. The following August you need the same $80,000, and $67,018.55 of the first loan is still outstanding. The options are a second term loan stacked on the first, a refinance that consolidates both and extends the amortisation again, or a short-term product that does not care about either. All three leave you carrying more permanent debt than the season ever required, and the third is the usual route by which a profitable seasonal retailer ends up on a daily debit.

A revolver avoids the ratchet because the same dollars come back. That is the whole argument, and it survives a rate difference of several points.

The covenant that catches seasonal borrowers

Beyond the clean-down, find out when the facility is reviewed and when any financial covenant is tested.

A leverage or coverage covenant tested at your peak inventory date measures you at the worst-looking moment of your year: stock at maximum, line fully drawn, and none of it converted to receivables yet. The same business tested in March passes comfortably.

Ask for the test date. If it falls inside your buying season, ask to move it, or to have the covenant tested on a trailing twelve-month basis. It costs the lender very little and saves you a technical default you would otherwise be explaining every single year.

What to have ready when you ask for a line

• Monthly sales for at least twenty-four months, showing the seasonal shape
• Inventory at cost, aged by season and category
• Sell-through and markdown history
• Open purchase orders with deposit and ship terms
• Supplier terms and payment record
• Bank statements covering a full peak and trough

What to ask, and what to refuse

Ask whether the facility is committed or repayable on demand, when it is reviewed, and what the clean-down requirement is. Ask what fees apply on the undrawn portion, and how quickly a draw funds — a line that takes a week is not useful at a trade show.

Refuse a term loan whose amortisation runs years past the life of the goods, unless it is the only credit available and you have written down the exit. Refuse an annual facility review scheduled inside your buying season. And refuse to size the buy off the credit you were offered rather than your worst realistic sell-through.