Inventory financing accounting for e-commerce: record loans, split interest, protect gross margin

How to Account for Inventory Financing: A Guide for E-commerce Businesses

For a growing e-commerce business, securing inventory financing feels like unlocking a new level of scale. The capital allows you to stock up for peak seasons, invest in new product lines, and eliminate the dreaded "out of stock" notice that sends valuable customers straight to your competitors. But after the initial relief of securing the funds, a new challenge emerges. The money has landed in your bank account, and the immediate question is: how do I account for inventory financing correctly? This is more than a simple compliance exercise, especially for founders managing their own books on platforms like QuickBooks or Xero.

Getting the accounting wrong can have serious consequences. It can distort your gross margins, create friction and reporting headaches with your lender, and lead to fundamentally misstated liabilities on your balance sheet. These errors can impact everything from your tax calculations to your ability to attract future investment. This guide provides a practical, step-by-step approach to managing the accounting from your first draw to your final repayment, ensuring your financial statements remain accurate, compliant, and useful for making strategic decisions.

Foundational Setup: Before Your First Draw

Before you draw your first dollar or pound, a few minutes spent setting up your accounting software will prevent significant issues down the line. The primary goal is to create dedicated accounts to isolate and track the loan and its associated costs. This discipline prevents the common but costly mistake of co-mingling financing activity with your daily sales revenue and operational expenses, which can obscure your true profitability.

Your first step is to modify your Chart of Accounts. In QuickBooks, you can do this by navigating to 'Accounting > Chart of Accounts > New'. In Xero, the path is 'Accounting > Chart of Accounts > Add Account'. You will need to add two specific accounts to properly manage the e-commerce inventory financing.

1. A Dedicated Liability Account: This account is where you will record the loan principal itself. The funds you receive are not revenue; they are a debt that you have a legal obligation to repay. You should create a 'Long-Term Liability' or 'Other Current Liability' account. Naming it something clear and specific, like "Inventory Loan Payable - [Lender Name]", makes it easy to track precisely how much you owe at any given time. This clarity is essential for managing cash flow and reporting to your lender.
2. A Dedicated Expense Account: This account is for tracking the costs of borrowing the money, which primarily include interest and any administrative fees. It should be classified as an 'Expense' or 'Other Expense' account, ensuring it is kept entirely separate from your Cost of Goods Sold (COGS). A clear name like "Financing Costs" or "Loan Interest & Fees" is best. Keeping this separate is crucial for protecting the integrity of your gross margin, your most important profitability metric.

This clean setup provides the foundation for accurate tracking and reporting, giving you a clear view of both your debt obligations and the true cost of your capital.

Part 1: How to Account for Loan Draws and Repayments

With your Chart of Accounts properly configured, recording the transactions becomes a straightforward process. The key is to recognize that every transaction has two sides, affecting different parts of your financial statements.

Recording the Initial Cash and Liability

When your lender deposits funds from your first draw into your business bank account, you need to book a journal entry that increases your cash (an asset) and simultaneously increases your liability (a debt). The money is a new asset on your books, but it arrives with an equal and opposite obligation to repay it.

Let’s say your US-based Shopify store secures a $50,000 draw from an inventory line of credit. In QuickBooks or Xero, the journal entry would reflect a debit to your cash account and a credit to your new liability account. A debit increases an asset, while a credit increases a liability.

Here is an example journal entry for the initial loan draw:

• Debit: Checking Account for $50,000.00
• Credit: Inventory Loan Payable - [Lender] for $50,000.00
• Memo: To record receipt of loan funds

This entry correctly shows your cash has increased while also recognizing the new $50,000 debt on your balance sheet. Crucially, it makes no impact on your Profit & Loss (P&L) statement because this is not revenue.

Splitting Principal and Interest in Repayments

When you begin making payments, it is essential to split each payment between the principal (the original amount you borrowed) and the interest or fees. This is a critical distinction with significant accounting implications. Principal repayment reduces your liability on the balance sheet, while interest is an operating expense that hits your P&L statement.

Imagine your first monthly payment is $2,500, which your lender's statement shows consists of $2,200 in principal repayment and $300 in interest. The journal entry must separate these two components to be correct.

An example journal entry for this split repayment would be:

• Debit: Inventory Loan Payable - [Lender] for $2,200.00
• Debit: Financing Costs & Interest for $300.00
• Credit: Checking Account for $2,500.00
• Memo: To record monthly loan payment

This entry correctly reduces the loan balance on your balance sheet by $2,200 and records a $300 business expense for the period. This meticulous approach ensures both your balance sheet and your P&L remain accurate, reflecting the true financial health of your business.

Part 2: The Borrowing Base and Inventory as Collateral

One of the most common operational requirements of inventory financing is the regular submission of a "borrowing base certificate." For founders and finance leads unfamiliar with asset-based lending, there is often confusion about what this report is and how to produce it accurately.

A borrowing base certificate is a report that details the value of your eligible inventory, which serves as the collateral for your loan. As the Journal of Accountancy notes when discussing asset-based lending, this mechanism is central to the structure of such loans. Lenders use the certificate to confirm you have sufficient inventory value to support your outstanding debt, which is how they manage their risk.

To calculate your borrowing base, the lender applies an "advance rate" to the value of different categories of your inventory. The advance rate is the percentage of the inventory's value they are willing to lend against. As trade finance publications often cite, "Lenders typically set an 'advance rate,' offering to lend a percentage of the inventory's value, commonly ranging from 50% for raw materials to 80% for finished goods." Finished goods command a higher rate because they are easier for a lender to liquidate in a worst-case scenario.

Generating this report requires accurate, real-time inventory valuations. While this sounds complex, the reality for most pre-seed to Series B startups is more pragmatic. The necessary data will typically come from your inventory system, such as Cin7 or Katana, or even a well-managed spreadsheet if your SKU count is small. You do not need a complex ERP to meet this requirement.

Consider this simple borrowing base calculation example:

• Finished Goods Value: $100,000
• Advance Rate on Finished Goods: 80%
• Borrowing Base Value (Finished Goods): $80,000

• Raw Materials Value: $20,000
• Advance Rate on Raw Materials: 50%
• Borrowing Base Value (Raw Materials): $10,000

In this scenario, your total borrowing base, or the maximum credit available to you, is $90,000 ($80,000 + $10,000). Keeping this report updated and accurate is a non-negotiable part of inventory-backed lending compliance. It prevents sudden draw restrictions, maintains a healthy relationship with your lender, and demonstrates strong financial controls.

Part 3: Handling Fees and Interest to Protect Your Gross Margin

Properly recording your financing costs does more than just keep your books clean; it directly protects the integrity of your most important e-commerce metric: gross margin. A common and costly error is to record interest and loan fees inside your Cost of Goods Sold (COGS). This mistake makes your products look less profitable than they actually are, which can lead to poor pricing decisions, skewed unit economics, and misinformed conversations with investors.

Financing costs are the cost of capital, not the cost of creating or acquiring your products. They belong "below the line" as an 'Other Expense' or 'Financial Expense' on your P&L, entirely separate from COGS. This ensures your gross profit (calculated as Revenue - COGS) reflects true product-level profitability. International accounting standards like IAS 23 on borrowing costs reinforce this principle of separating financing costs from direct production costs.

This separation has important tax implications that differ by geography.

• In the UK: For businesses using Xero, this is particularly relevant for VAT purposes. Financing costs, such as loan interest, are typically exempt from VAT. If you mistakenly categorize these costs within COGS, which are inputs for your VAT calculations on sales, you could unnecessarily complicate your VAT return. Keeping them separate in a dedicated expense account ensures your VAT reporting is straightforward and correct under FRS 102.
• For US companies: Using QuickBooks, the main concern relates to federal and state corporation tax. While sales tax is applied at the point of sale, your gross profit is the starting point for calculating your taxable income. Artificially deflating your gross profit by including financing costs in COGS can create an inaccurate picture of your operational profitability. This is a key area of focus for tax authorities and auditors under US GAAP, and clear, accurate reporting is essential.

In practice, we see that diligently segregating these costs not only ensures compliance but also provides founders with a much clearer view of their unit economics. This clarity enables smarter decisions about pricing, marketing spend, and overall business growth.

Practical Takeaways for E-commerce Founders

Successfully managing the accounting for inventory financing does not require a dedicated CFO or a complex ERP system. It comes down to a few disciplined practices that can be implemented today in standard software like QuickBooks or Xero. For e-commerce founders juggling growth and cash flow, getting this right provides the financial clarity needed to scale with confidence.

What founders find actually works is focusing on these four key actions:

1. Set Up Your Accounts First. Before a single dollar of the loan is drawn, create a dedicated liability account (e.g., "Inventory Loan Payable") and a separate expense account (e.g., "Financing Costs"). This foundational step prevents the majority of common errors and ensures your transactions are categorized correctly from day one.
2. Record Transactions Accurately. Treat every loan draw as a debit to cash and a credit to your new liability account. It is not revenue. For repayments, meticulously split the payment between principal (a debit to the liability account, reducing the loan) and interest (a debit to the financing costs account, hitting your P&L).
3. Establish a Borrowing Base Process. Your lending agreement will require regular borrowing base certificates. Create a simple, repeatable process using data from your inventory management system to calculate this. It is a key compliance requirement for tracking inventory as collateral and avoiding interruptions to your credit line.
4. Protect Your Gross Margin at All Costs. Never mix financing costs with your Cost of Goods Sold (COGS). This simple but critical distinction ensures your product profitability metrics are accurate, which is essential for strategic planning, investor reporting, and correct tax filings in both the UK (VAT) and US (corporation tax).

By implementing these steps, you transform inventory financing from a potential accounting headache into a clearly managed strategic tool. This clarity allows you to focus on what the capital is for in the first place: growing your business.

Frequently Asked Questions

Q: What is the difference between inventory financing and a standard business loan?
A: A standard business loan provides a lump sum of cash based on your overall business creditworthiness. Inventory financing is a type of asset-based lending where the loan amount is directly tied to the value of your inventory, which serves as collateral. The available credit can fluctuate as your inventory levels change.

Q: Is inventory financing considered debt on the balance sheet?
A: Yes, absolutely. The funds received from an inventory loan are a liability, not revenue. It should be recorded on your balance sheet in a dedicated liability account, such as "Inventory Loan Payable." This ensures your financial statements accurately reflect your company's obligations.

Q: Can I include financing interest in my inventory's value?
A: Generally, no. Under both US GAAP and UK accounting standards (FRS 102), interest costs from financing are treated as a period expense and recorded on the Profit & Loss statement. They should not be capitalized into the value of your inventory on the balance sheet. This maintains a clear separation between product costs and financing costs.

Q: How does my accounting software help with inventory loan bookkeeping?
A: Software like QuickBooks and Xero allows you to create the necessary liability and expense accounts. You can also set up bank rules to automatically split repayments between principal and interest, which saves time and reduces errors. These platforms are essential for generating the financial reports needed for lender compliance.