Purchase Order Financing: Your solution to importer, wholesaler, and trade cash flow management
Purchase order financing is a method to finance your order when enough working capital is not available. Cash is advanced against your purchase order for completed goods to fund manufacturing costs. This method of lending does not apply to service-based businesses. Service-based companies are usually the main beneficiaries of funding methods such as invoice factoring.
Cash inflow is the lifeblood of any company. In relation to this fact, there are two major key drivers when it comes to achieving a positive cash flow: organization and planning. However, most businesses, at different stages, ultimately encounter cash flow problems that can range from making delay payrolls to lacking funds to take advantage of a growth opportunity. Moreover, with the right funding strategy and anticipation, these issues can be prevented. Purchase order financing is one of the most favorable solutions to resolve the lack of working capital to fund purchases for resale.
What is Purchase Order Financing?
Unlike invoice factoring which accelerates the cash from your invoices, a purchase order loan or PO financing gives you the ability to have goods available for your clients from your sources before an invoice is generated. You will also hear the terms Vendor Guarantees, Supplier Financing, Accounts Payable Financing, Trade Financing, Letters of Credits or PO Funding to describe this type of working capital arrangement.
Purchase order financing (POF), also referred to as Supplier Financing, Accounts Payable Financing, or Trade Financing is a type of “asset-based lending”, a specialized method of providing working capital and term funds secured by assets such as accounts receivable, inventory… Purchase order financing is a short-term commercial funding option that accommodates businesses’ financial needs when enough working capital is unavailable; by providing an upfront payment or credit enhancement to suppliers for verified purchase orders so as to fund the business product costs.
PO financing gives any business the ability to have goods available for its clients from its sources before an invoice is generated. If you are a product importer, reseller or distributor, and need capital to deliver a large purchase order, then Purchase Order Financing can be the perfect solution to fuel your business with the cash you need, not only to deliver your orders but also to grow your business. PO financing enables you to make sales that exceed your current financial capabilities.
Therefore, PO financing is a funding tool allowing goods-based businesses to:
- Raise additional working capital without cumulating debts
- Improve their business cash flow
- Benefit from discounts on their material purchases
- Finance rapid sales growth
- Pay back taxes and liens
- Outsource the credit/collection process and benefit from professional expertise
How does Purchase Order Financing work?
POF is convenient for any business that lacks funds, has stretched its credit limits with vendors and is not eligible for a bank loan or has consumed its lending capacity. This method of funding does not apply to service-based businesses as it engages one company (the lender) to pay the supplier for providing needed goods; allowing the business client to perform the job for its customers. Prior to remitting the remaining balance to the client once the orders have been fulfilled and paid for, the lender then deducts its fees.
To qualify for purchase order financing, a company must have B2B or B2G customers and hold a minimum profit margin of 15%. The application approval depends on the creditworthiness of, and your past history with, your suppliers and customers. Well established and reputable customers and suppliers can make the whole process easier.
For example, a Wholesale Company receives a purchase order from its customer worth $150,000. The company needs to prepay or guarantee payment to its supplier for $95,000 to deliver the needed goods and is lacking the required funds. In this scenario, the B2B or B2G Company reaches out to the POF company for a financing contract. POF company would proceed as follow:
- Review that the transaction complies with the funding requirements.
- Issue a Letter of Credit, Cash Against Documents, or a Vendor Guarantee for $95,000 to the supplier allowing him to deliver the goods.
- Inspect that the goods are delivered and accepted by the customer.
- The invoices that are created are then factored so the PO funder is paid their monies plus their earned fees.
As mentioned in the last bullet point, the Wholesaler Company would be able to invoice its customers and factor the invoices who in turn pays the POF company, which would be considered a conventional factoring transaction. POF companies prefer either direct payment or payment made from a factoring company. If the entire amount is remitted to the POF, the remaining balance goes to the Wholesaler Company Client after deducting the already paid amount ($95,000) plus fees. Rates are usually based on volume and utilized funds.
How is Purchase Order Financing different from Invoice Factoring?
If your business needs funds, then it is crucial to identify when to use invoice factoring and when to use PO financing.
Purchase order financing:
POF is an upfront payment or a guarantee of payment addressed to a supplier. A PF company initiates this process on behalf of its client to help him fulfill a customer order. Additionally, the financing company rates that can vary from .35 to 5% along with other transactional costs such as product inspection, storage, insurance, tariffs, and duties.
The minimum requirements to be eligible for this type of funding:
- Creditworthy supplier and customer
- Profit margin 15%+
- Biz2Biz or Biz2Govt
- Goods-Based business
Invoice factoring is a loan or an upfront payment based on an already delivered invoiced goods or services. Factors apply monthly rates that vary from .75 to 3%.
The minimum requirements to qualify for this type of funding are as follow:
- Credit-worthy customers
- Invoices due in less than 90 days
- Biz2Biz or Biz2Govt
- Goods or services based business
- True Sale vs Consignment or Guaranteed Sale
It is important to note that the Invoice Factoring process is independent of the PO process. On the other hand, PO financing can’t happen without Invoice factoring, in terms with the Vendor Guarantees which is an agreement between the business client, its supplier, and the factoring company. The factor pays directly to the business’s supplier, out of the factored invoices proceeds. Thus, the factor would only make the payment if the business client agrees to factor invoices.
What are Purchase Order Financing’s Benefits?
- Balance Sheet Issues?
- Bank Line Too Small?
- Hyper Growth?
- Need a Defacto Credit Department (Credit Protection)?
POF is your most favorable funding solution for buying and selling goods in the same physical state. This method is quite advantageous because it is easier for your business to qualify for it in comparison with bank financing as the focus is mainly on the creditworthiness of your business’ customers rather than your own credit.
The benefits of reaching out to a Purchase Order Financing Company include:
- Up to 100% funding of your inventory cost
- PO Financing is not a loan so less debt on your balance sheet
- Payment Guarantee or Paid Delivery for your suppliers.
- You can take bigger orders
- The credit facility grows with your ability to sell and capture PO’s
- You can benefit from the PO Funding Company’s fulfillment and logistics expertise