Floor planning is a type of inventory financing for large-ticket items. It’s commonly used in the retail industry, particularly in sectors like car dealerships, recreational vehicle and boat dealers, appliance stores, and furniture stores.
Here’s how it works:
- A retailer plans to sell a number of high-cost items but does not want to, or cannot afford to, purchase these items outright from the manufacturer.
- The retailer turns to a finance company or bank that offers a floor plan line of credit. The finance company pays the manufacturer for the goods, which are then delivered to the retailer’s showroom.
- The retailer sells the items to customers, and when a sale is made, the retailer repays the finance company for the cost of the sold item, usually with interest.
- The remaining unsold goods serve as collateral for the loan. If the retailer cannot sell the goods and repay the loan, the finance company can seize the unsold goods.
Floor planning allows retailers to stock a large variety of high-cost items in their showrooms without needing significant amounts of capital. This type of financing is particularly useful for businesses where inventory items are expensive and the turnover rate is slower.
Example of Floor Planning
Let’s consider an example of a car dealership:
- The dealership wants to stock a variety of new car models to attract potential customers but doesn’t have the capital to purchase these cars outright from the manufacturers.
- The dealership approaches a bank that offers a floor planning line of credit. The bank agrees to pay the manufacturers for the cars, which are then delivered to the dealership.
- Over the next several months, the dealership sells the cars to customers. As each car is sold, the dealership takes the proceeds and repays the bank for the cost of that car, plus interest.
- If, after a certain period, there are cars that the dealership has not been able to sell, the bank has the right to seize those cars as repayment for the loan.
This arrangement allows the dealership to showcase a wide range of cars without having to bear the high upfront costs. It also spreads the financial risk between the dealership and the bank. The dealership gets the advantage of better cash flow management, while the bank earns interest on the loaned amount. However, the risk to the bank is mitigated because the unsold cars serve as collateral for the loan.