A Comprehensive Guide to Purchase Order Financing

Businesses face a lot of challenges in their day-to-day operations, and most businesses, 82% to be exact, are even facing problems with cash flow management, which directly contribute to failure in the long term. This not only delays business growth but also seeds an environment of unaccountability. All this results in imbalanced accounts, expansion barriers, and losses to the business. From this point, the trajectory tends to be downward. If your business is grappling with these issues, there’s no need to panic. The solution lies in PO Financing.

Purchase order financing, if implemented correctly, is one of the best financial strategies that lets businesses fulfill bulk orders, cultivate stronger supplier relationships, efficiently manage cash flow, mitigate risks, and capitalize on sales opportunities that come your way.

In this article, we will discuss insights into the workings of PO financing, understanding its pros and cons, and much more to equip you to overcome cashflow challenges and build a strong back for your business.

What Exactly Is PO Financing?

PO Financing or Purchase Order Financing is a short-term financial solution that businesses can employ to cover the expenses of acquiring or manufacturing goods that have been presold to customers through a purchase order. In simple words, it is a situation when you receive a purchase order for a product that is not currently in your inventory. To fulfill the order, you must either manufacture or outsource them – and you lack the cash flow as well for these options.

So rather than rejecting the business opportunity altogether, you can contact a PO financier.  A PO financing company directly pays your suppliers in your stead. After fulfilling the order, you invoice the client, and the client makes the payment directly to the finance company. Subsequently, the financing company transfers the balance payment, after deducting its service charges, to you. This streamlined process enables you to fulfill orders without waiting for funds to arrive from the buyer.

The interesting thing about this service is that, unlike traditional lenders, PO financiers are open to funding suppliers even if their credit scores are low. These lenders prioritize the creditworthiness of your client who is making the order. Moreover, securing a loan from traditional lenders is a long process, assuming you’re fortunate enough to qualify. Whereas, obtaining purchase order loans is significantly more straightforward. This ease of access is particularly advantageous for companies that are in their initial stages and might face unexpected large purchase orders when they are not fully prepared.

Understanding The Process Of PO Financing

Purchase order financing differentiates itself from conventional business loans by involving more parties. While a business loan typically involves just the lender and you as the borrower, purchase order financing includes four key participants: your business, the purchase order financing company, your customer, and the supplier.

Let’s discuss the overview of how this process unfolds:

• Receiving a Big Order: When your business gets a large purchase order, whether from a new or existing customer, your supplier usually asks for payment upfront. The customer’s invoice won’t be settled until 60-90 days after the delivery. This time gap creates a common challenge known as a working capital gap.
• Cost Determination: You Start by assessing the costs. Reach out to your supplier to determine the expenses associated with completing the order. This cost evaluation from your supplier helps you ascertain whether applying for financing is necessary to fulfill the order.
• Application for PO Financing: You seek out an appropriate PO Financier. Apply, including the PO total estimate of the order. Approval hinges on various factors such as your business qualifications, the track record, reputation, and creditworthiness of the customer. It’s crucial to note that if the financing company approves only a portion of the funding, let’s say 70% of the supplier’s costs, you will be responsible for covering the remaining 30% independently.
• Payment Process: The process involves direct payment to suppliers, either through a letter of credit or in cash.
• Invoicing the Customer: Your business fulfills the order and issues an invoice for the order. Simultaneously, you forward the invoice to the PO financing company.
• Payment to Financing Company: The customer remits payment directly to the purchase order financing company, covering the entire invoice amount.

This method offers a practical solution to bridge the financial gap, ensuring the successful execution of significant orders. It’s a reliable way to keep business flowing smoothly, especially when dealing with substantial transactions.

Why PO Financing Is Better Than Traditional Loans?

PO Financing offers a structured term and a defined revenue stream where payments tied to a specific project are allocated, without tying a long-term commitment. This financing option can be utilized repeatedly as you secure additional orders, maintaining the same setup and advantages. In contrast, term loans and LOC can be refinanced, but early payment or origination fees may eat a substantial portion of your margins.

To offset the costs, many companies prefer to give a cut of profit for earnings in the short term with PO financing rather than traditional loans with floating interest rates. This approach is more manageable from order to order compared to going through long new contracts plus their initial expenses. Ultimately, PO Financing emerges as a more cost-effective and flexible solution for acquiring the capital essential for business financing.

Advantages Of PO Financing

If you’re grappling with acquiring the necessary supplies to fulfill an order or encountering cash flow hurdles, purchase order financing could be the ideal solution. Consider these key advantages:

• Ideal for Startups

Startup owners often find themselves caught in a challenging situation. Securing funding is tricky due to a lack of an established track record, yet the company is in rapid growth mode.

Turning down a customer’s order can significantly impede the company’s growth potential. Purchase order financing provides a means to satisfy all customer orders while stabilizing cash flow, a crucial benefit for startups.

• Flexible Funding

While purchase order financing involves borrowing money, it’s technically not a traditional loan. In times of cash flow strain, you can leverage outstanding purchase orders for funding.

Moreover, you have the flexibility to finance up to 100% of your costs in a lump sum without the obligation of repaying the money through installments. Unlike long-term commitments associated with SBA loans and bank loans, purchase order financing is transaction-focused and offers remarkable flexibility.

• Business Opportunities

For numerous companies, the pace of growth often outstrips the incoming funds. In such situations, purchase order financing becomes a significant asset. When cash flow is constrained, and your business is in a swift growth phase, upfront expenses for essential business needs might be challenging to meet.

With PO financing – a solution that allows your company to acquire the necessary supplies without disrupting operations or waiting for an uptick in cash flow.

• Enhanced Cash Flow

Not only for startups, PO financing serves as a crucial source of funds for fulfilling the PO of various types of companies, enabling businesses to steer through cash flow challenges and capitalize on growth opportunities. It effectively addresses the timing gap between the upfront payment required by suppliers and the reseller’s ability to settle the invoice after goods delivery.

• No Collateral Requirement

In contrast to typical business loans that often demand a personal guarantee, PO financing is typically non-recourse. This means that in the event of the client’s inability to pay, the lender assumes the risk, and you are generally not held personally accountable.

Whether the client cancels the shipment, expresses dissatisfaction with the product, faces financial distress after delivery, or fails to pay for any other reason, the lender bears the financial risk. However, it’s advisable to discuss the lender’s procedures in case of customer non-payment in advance.

Disadvantages Of PO Financing

• Limited Funding Scope

In contrast to traditional business loans, purchase order financing is typically confined to the specific amount required for fulfilling a particular purchase order.

The lender’s support is tailored to cover the expenses directly associated with the purchase order, encompassing costs such as raw materials, manufacturing, and shipping.

• Inapplicable to Service Businesses

For businesses to qualify for purchase order financing, they must deal with physical goods that the supplier can manufacture and deliver to customers. Unfortunately, PO financing is not an option for service-oriented businesses.

If your business provides services and invoices customers accordingly, exploring invoice financing might be a more suitable alternative for your financial needs.

• Customer Interaction with the Lender

Another drawback of purchase order financing is that the customer settles payments directly with the lender upon goods delivery. This implies that your customers will be aware of your utilization of financing, potentially influencing their perception of your business.

Is PO Financing Costly?

Yes! It is true, that PO financing may come with significant costs, much more than normal loans. The fees generally fall within the range of 1% to 6% of the PO value per month.

While these percentages might not seem that significant, it’s crucial to grasp the bigger picture when seen in the long term. For instance, just 2.5% of the month-on-month loan rate translates to an APR of 30%. Understanding these figures is essential for making informed financial decisions in the realm of purchase order financing.

When Is PO Financing Right For You?

This financing option appeals to businesses grappling with substantial orders but lacking the necessary funds or resources to meet the demand. PO financing empowers businesses to secure the required funds for order fulfillment by borrowing against the value of the purchase order. In practical terms, the lender directly pays the supplier for the goods or services, enabling the business to fulfill the order without immediate expenses that you are unable to cover.

However, careful consideration of the risks and costs associated with PO financing is crucial before moving forward. PO financing expenses can be substantial, involving interest rates, fees, and additional charges from lenders. Moreover, if the business encounters challenges in fulfilling the order, the lender may demand repayment of the borrowed funds, potentially causing financial difficulties.

Hence, conducting thorough due diligence and collaborating with a reputable lender before opting for PO financing is vital. This means a meticulous review of the T&Cs of the term you are opting for, an assessment of the lender’s track record, and a comprehensive understanding of potential costs and risks. By undertaking these steps, businesses can make well-informed decisions about whether PO financing aligns with their needs and avoid potential pitfalls in the future.

How To Get Purchase Order Financing?

Applying for PO financing typically can be applied through an online application form through a reliable service provider or you can also contact your bank to check if they can help secure PO financing. Moving on, to start the process, you’ll be required to present the financial institution with essential documents—a purchase order from the customer and the pro forma invoice from the vendor.

Approval timelines may extend over a few weeks, especially if this is your first time and that too with a new financial institution. Throughout the evaluation, the finance company considers various criteria to determine fees and approval. These considerations include:

• Transaction Suitability: Certain finance companies may specialize in specific product types or necessitate a minimum transaction amount.
• Customer Creditworthiness: The credit history of your customer’s business holds significant weight in the evaluation.
• Supplier Reliability: Lenders exhibit a preference for financing orders from well-established suppliers without financial issues.
• Company Qualification: The lender may scrutinize your financial statements, supplier and client contracts, and public records to assess your business’s capability to fulfill the order.
• Owner Qualifications: Business owners with relevant experience and an absence of legal complications are typically preferred by lenders.

Here are the Qualifications Required for Purchase Order Financing

• Established Business: Funding providers generally prefer collaborating with businesses boasting a track record and a proven history of successful operations.
• Purchase Order Contracts: Your business needs solid purchase order contracts from creditworthy customers. The customer’s creditworthiness significantly influences the approval process.
• Profit Margins: The transaction’s profitability is a pivotal consideration. Funding providers scrutinize profit margins to ensure that the transaction generates ample returns to cover financing costs.
• Supplier Capability: The supplier’s ability to fulfill the purchase order holds paramount importance. Funding providers assess the supplier’s capacity, reliability, and competence to deliver products or services promptly.

Best Alternatives To PO Financing

• Traditional Bank Loans:

B2B businesses have the option to approach banks for LOC and term loans. The amount is determined based on the business’s collateral and creditworthiness.

• Invoice Financing:

Instead of financing purchase orders, businesses can utilize their accounts receivable by selling invoices to a financing company at a discounted rate.

• Business Credit Cards:

Business owners can address short-term loan needs using credit cards. However, it’s crucial to manage the debt of the credit card diligently and be mindful of associated interest rates.

Conclusion

Many businesses face challenges with managing their cash flow. To face this challenge, there is a solution called Purchase Order Financing that can help. By utilizing this term option strategically businesses can not only overcome cash flow constraints but also take advantage of growth opportunities.

The process involves parties and a streamlined payment system providing a way to fulfill large orders. However, it’s important for businesses to carefully consider the costs, risks, and alternatives associated with PO Financing. By approaching it with knowledge and working alongside lenders, businesses can effectively harness the benefits of this financing method.

Frequently Asked Questions