Distribution finance is a form of asset-based lending that gives distributors a revolving credit line secured by the inventory they hold and the invoices their customers owe. Instead of waiting 60 or 90 days for a customer to pay, or tying up cash in warehouse stock, you draw against those assets as working capital. The balance rises when you buy inventory, falls when customers pay, and the operating cycle itself is the repayment mechanism. That self-liquidating structure is what makes distribution finance both useful and demanding to manage.
How the Borrowing Base Works
Every facility is built around a borrowing base, the formula that controls how much you can draw at any moment. The lender assigns advance rates to each category of eligible collateral. Per 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 the amount the inventory would bring in a quick but organized sale.1OCC.gov. Asset-Based Lending – Comptrollers Handbook
A quick example. Say you have $500,000 in eligible receivables and $300,000 in eligible inventory. If the lender sets an 80 percent advance rate on receivables and 60 percent on inventory, your borrowing base is $580,000: $400,000 plus $180,000. You can draw up to that ceiling, and the ceiling adjusts daily as you sell goods, generate new invoices, and collect payments. The word “eligible” is doing real work. Not every dollar on your books counts.
As inventory sells, it converts into accounts receivable. When those receivables collect, the cash flows to the lender and reduces the outstanding balance. Borrowing capacity then frees up again for your next inventory purchase. That recycling of collateral into cash into new collateral is the engine of the whole structure.
The Three Main Types of Distribution Finance
Distribution finance breaks into three products, each aimed at a different point in 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 paying your supplier and getting paid by your customer.
Inventory and Floorplan Financing
Inventory financing provides capital to purchase and hold physical goods. When the 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 require electronic tracking or send auditors unannounced to confirm each financed item is still on your lot or in your warehouse. When you sell a financed item, you must notify the lender and remit the corresponding principal immediately. The OCC describes curtailment schedules under which, if an item hasn’t sold within a set period (commonly 90 days), you start making partial principal payments of around 10 percent of the original loan balance per month to protect the lender against obsolescence or value loss.2OCC.gov. Floor Plan Lending – Comptrollers Handbook
Some manufacturer-backed programs offer an interest-free period, sometimes called “free floor,” during the first 30 to 90 days after the inventory ships. It’s effectively a subsidy from the manufacturer to encourage distributors to carry more stock. After the free period, interest accrues at the contractual rate until the item sells or hits its curtailment deadline.
Accounts Receivable Financing
Once the goods are sold, you usually wait 30 to 90 days for your customer to pay. Accounts receivable financing closes that gap through two structures: factoring and revolving AR lines of credit.
Factoring is an outright sale of your invoices to a finance company, called the factor. You receive an immediate advance of 75 to 90 percent of invoice face value, and the factor collects directly from your customer. The remaining balance, less the factor’s fee, is paid to you after collection. The fee generally runs 1 to 5 percent of the invoice value, depending on your customers’ creditworthiness, payment terms, and volume. In recourse factoring, you bear the risk if the customer doesn’t pay. In non-recourse factoring, the factor absorbs that credit risk on approved accounts.
A revolving AR line of credit works differently. You keep ownership of your invoices and handle collections yourself; the receivables simply serve as collateral for the loan. Pricing is structured as an interest rate, often a spread over SOFR or prime, plus administrative and monitoring fees, rather than a per-invoice factoring fee. The structure is usually cheaper for distributors with high invoice volume and reliable customers, but it requires stronger internal bookkeeping because you still run collections.
Whichever structure you use, lenders impose strict eligibility rules on which receivables count toward the borrowing base. Invoices older than 90 days past the original due date are almost always excluded. Lenders apply concentration limits, typically capping any single customer at around 20 to 25 percent of the receivables pool. If one customer represents too large a share of your outstanding invoices, the excess won’t count toward available credit.
Cross-aging rules catch many 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 may disqualify every invoice from that customer, not just the late ones. A single slow-paying account can drop out of your borrowing base overnight.
Supply Chain Finance
Supply chain finance, sometimes called reverse factoring, flips the model. Instead of financing what your customers owe you, it optimizes what you owe your suppliers. A third-party financier, usually a bank, pays your supplier early at a small discount, sometimes within days of invoice approval. You then repay the financier on extended terms, often 90 to 120 days later.
The pricing is based on your credit profile rather than your supplier’s. If you’re a large distributor with a strong balance sheet, the discount rate reflects your low borrowing cost, which makes early payment attractive to suppliers who would otherwise wait or borrow at higher rates themselves. Supply chain finance platforms automate the matching of approved invoices to the financier and reconcile payments across your supplier base. The structure works best for distributors with enough purchasing power and creditworthiness that a bank is willing to underwrite the program.
What Distribution Finance Costs
Cost varies significantly by product type, collateral quality, and the distributor’s credit profile. There is no single rate for distribution finance because the pricing components differ across structures.
For revolving lines secured by inventory or receivables, lenders charge an interest rate expressed as a spread over a benchmark, plus ongoing fees for collateral monitoring, field audits, and borrowing base administration. Audit fees alone can run several thousand dollars per examination, and lenders may conduct two to four per year. Expect an unused line fee, a small percentage charged on the undrawn portion of the facility to compensate the lender for reserving capacity.
Factoring is priced as a fee of 1 to 5 percent of the invoice, functioning as a discount on the receivable. Longer customer payment 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 costs include an interest rate on outstanding principal, curtailment penalties on inventory that ages past its scheduled turn date, and audit fees. Some manufacturers subsidize part of the cost during promotional periods, which can significantly reduce the effective rate.
Across all structures, expect closing costs for legal documentation, UCC filing fees, inventory appraisal costs, and possibly an origination or commitment fee. Those upfront expenses add up, so distribution finance makes the most economic sense for businesses with enough volume to spread fixed costs across a large borrowing base.
Qualifying for a Facility
Lenders underwrite based 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.
Financial Health
Lenders want a track record, usually two to three years of operating history with consistent revenue. They’ll examine trends in gross margins, operating expenses, and cash flow to confirm you generate enough to cover debt service. Strong internal financial controls matter too, because you’ll be producing borrowing base certificates and inventory reports on tight deadlines. If the lender can’t trust your numbers, the facility doesn’t work.
Collateral Quality
For receivables, lenders look at customer creditworthiness, invoice aging, concentration risk, and payment patterns. A diverse customer base where no single buyer exceeds 20 to 25 percent of receivables is ideal. High concentration, slow-pay patterns, or significant disputed invoices will shrink your borrowing base or disqualify you.
For inventory, the question is simple: how quickly and reliably can this be sold in a liquidation? Standardized, brand-name goods with active secondary markets get the highest advance rates. 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
Documentation Required
Underwriting takes a substantial document package:
- Inventory schedules listing quantities, locations, costs, and aging.
- AR aging reports broken out by days past due, customer, and dollar amount.
- Historical sales data 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 and proof of authority to borrow.
- Forward-looking financial projections for 12 to 24 months.
The UCC Framework Behind the Loan
Distribution finance sits on a legal foundation defined almost entirely by Article 9 of the Uniform Commercial Code, which governs how a lender establishes, documents, and enforces its claim on your collateral.
The Security Agreement
The security agreement is the contract that grants the lender a legal interest in specified collateral: inventory, accounts receivable, equipment, and sometimes broader asset categories. Under UCC Article 9, a security interest attaches, meaning it becomes enforceable, only when three conditions are met. The lender has given value, you have rights in the collateral, and you’ve signed a security agreement that describes the collateral.3Legal Information Institute. Uniform Commercial Code 9-102 – Definitions and Index of Definitions
Perfection and Priority
Attachment alone doesn’t protect the lender against competing creditors. To establish priority, the right to be paid first if things go wrong, the lender must perfect its security interest. For most distribution finance collateral, perfection requires filing a UCC-1 financing statement with the designated state filing office, usually the Secretary of State.4Legal Information Institute. Uniform Commercial Code 9-310 – When Filing Required to Perfect Security Interest or Agricultural Lien The filing creates a public record that puts other creditors on notice.
There are exceptions. For collateral governed by other statutes, such as motor vehicles under a certificate-of-title system, a UCC filing alone won’t do the job. The lender must comply with the applicable title statute.5Legal Information Institute. Uniform Commercial Code 9-311 – Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties That matters for distributors in auto, marine, or heavy equipment, where certificate-of-title laws override standard UCC filing.
Ongoing Obligations Once the Facility Is Live
A distribution finance facility is not a set-it-and-forget-it loan. Once signed, you’re subject to financial covenants and reporting duties the lender monitors closely. Falling out of compliance, even technically, can restrict your borrowing or accelerate the entire facility.
Financial Covenants
Lenders tailor covenants to the distributor’s 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 liquidation value.
Borrowing Base Reporting
You’ll submit a borrowing base certificate on a regular schedule, often daily or weekly. The certificate calculates your current available credit based on eligible receivables and inventory at that moment. The lender uses it to approve or restrict draws in near real time. Submitting an inflated certificate isn’t just a breach of the agreement; it’s 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 show up at your warehouse periodically to count inventory, inspect its condition, and reconcile what they see against what you’ve reported. For receivables, auditors verify that key customers exist, confirm that high-value invoices are legitimate, and check for disputes or offsets that would reduce amounts owed. Audits happen multiple times a year, sometimes without notice, and the distributor typically pays.
Lockbox and Cash Dominion
Most asset-based lenders require a lockbox arrangement, where customers send payments to a bank-controlled account rather than directly to you. Under full dominion, the bank applies collections to your loan balance before releasing any remaining funds. Under springing dominion, the bank passes cash through to you normally but reserves the right to seize control if you breach the agreement.1OCC.gov. Asset-Based Lending – Comptrollers Handbook Either way, the lender maintains a direct pipeline to your incoming cash. That’s the mechanism that makes the facility self-liquidating, and it’s one of the biggest operational adjustments for distributors used to controlling collections themselves.
What Happens If You Default
Default in distribution finance carries consequences well beyond a late fee. The lender’s UCC remedies are broad and move quickly.
Lender Remedies
After default, a secured party can pursue any available judicial remedy, foreclose on the collateral, or take possession and sell it.6Legal 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 them simultaneously. In practice that means sweeping your lockbox account, seizing warehouse inventory, and filing suit for any deficiency, all at once.
Most 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 specific breach. Cross-default provisions may link your distribution finance facility to other loans, so a default here can cascade into defaults elsewhere.
Selling Out of Trust
The most dangerous default in floorplan financing is “selling out of trust,” which means selling financed inventory and failing to remit the proceeds to the lender. 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 produce criminal charges. There is no grace period and no ambiguity about whose money the proceeds are 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, meaning bankruptcy protection won’t eliminate it.