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What is Purchase Order Financing?

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Purchase order financing is a type of funding that your business can use to pay for the materials or goods needed to fulfill outstanding purchase orders. This type of financing can be a viable option for businesses in a number of industries, including manufacturers, wholesalers, distributors and import/export companies.

What is purchase order financing?

Purchase order financing is a short-term financing method that businesses can use to cover the cost of manufacturing or purchasing goods that have been presold to customers via a purchase order.

Say you receive a purchase order from a customer for goods you don’t have in stock. To fulfill the order, you’ll need to either manufacture the products or purchase them from someone else, but you don’t have the cash on hand to do either.

Rather than turning away business, a purchase order financing company pays your suppliers directly. Once you fulfill the order, you invoice the client and have them pay the finance company. Then the financing company sends the payment (minus its fee) to you.

This process allows you to fill orders without having to wait for the funds to come through from the buyer.

Purchase order financing costs

Purchase order financing can be a costly endeavor, with fees typically ranging from 1.8% to 6% of the purchase order value per month.

That might not sound like a lot, but when you convert it to an annual percentage rate (APR), a 3.5% monthly loan rate works out to an APR of over 40%.

How does purchase order financing work?

One of the ways purchase order financing differs from a normal business loan is that there are more parties involved. A business loan involves only the lender and you as the borrower. But with purchase order financing, there are four parties involved: your business, the purchase order financing company, your customer and the supplier.

Here’s an overview of how the process works:

  • Your business receives an order. Your business receives an order from a customer, but you don’t have the cash or inventory on hand to fulfill it.
  • You apply for purchase order financing in order to fill the order. You submit an application to the purchase order financing company. If the financing company approves your application, they may cover up to 100% of the supplier’s costs, depending on your supplier’s track reputation and your customer’s creditworthiness. If the financing company approves you for only a percentage of funding, you’ll have to cover the remaining balance.
  • The purchase order financing company pays the supplier to manufacture and deliver the order. Once your application is approved, the purchase order financing company will pay your supplier directly, which may be sent as a letter of credit rather than cash. A letter of credit is a bank guarantee that payment will be made once certain conditions are met (in this case, the condition would be that proof is provided that the goods have been shipped).
  • You invoice your customer. Once the customer receives their order, you send an invoice to the customer and an invoice copy to the financing company.
  • The customer pays the financing company. Your customer pays the financing company directly.
  • The financing company deducts its fee and transfers funds to your company. After the finance company receives payment from your customer, it deducts its fee from the payment and sends the remaining balance to you.

Pros and cons of purchase order financing

Purchase order financing has several advantages over other forms of financing, but there are downsides as well. Here’s a look at the pros and cons.

ProsCons

  Available to new businesses and startups. Many traditional lenders require a company to be in business for a year or more before they’ll approve a loan. Purchase order financing may be available to startups that are growing rapidly but don’t have the long history banks and other lenders want to see.

  Credit is less of a factor. Businesses with lower credit shouldn’t have a problem getting funding as long as the customer making the purchase has good business credit.

  Faster funding. Bank loans can take weeks or even months to get from application to funding. Purchase order financing can happen within a matter of days.

  Limited uses. Purchase order financing can’t be used for all types of working capital needs — it’s only available for covering supplier expenses. Many purchase order financing companies also require a minimum expected profit margin from the order of at least 20%.

  Might not cover 100% of the cost of an outstanding purchase order. If the PO financing company doesn’t approve 100% financing, the business will have to cover the rest of the cost.

  Can strain customer relationships. Customers know they’re paying a lender, not your business. This could impact your reputation or strain the customer relationship.

Purchase order financing companies: Where and how to get funding

Here’s a list of PO financing companies to consider:

  • SouthStar Capital. SouthStar Capital offers 100% financing on purchase orders and can provide funding in as little as two to five days. The company will even advance the amount of the order invoice to you as soon as the customer receives their order, so you don’t have to wait 30, 60 or more days for the customer to pay the invoice before you get paid.
  • Commercial Capital LLC. Commercial Capital LLC works with businesses in the U.S. and Canada on orders of $100,000 or more with a gross profit margin of at least 20%.
  • Express Trade Capital. Express Trade Capital finances up to 100% of the cost of presold goods, along with the cost of transportation, customs and duties.
  • Star Funding, Inc. Star Funding, Inc. will finance up to 100% of a purchase order, whether you need to purchase goods for resale or buy components from several vendors to produce goods in-house. Rates will vary depending on the size and duration of the transaction, but usually range from 2% to 5% per 30-day period.

How to get purchase order financing

The application process typically begins with filling out an online form or a phone call. You’ll need to provide the lender with a purchase order from the customer and the pro-forma invoice from the vendor.

Approval might take some time — possibly a few weeks if this is your first time applying for financing with the lender.

Some of the criteria the finance company will consider when evaluating your application and determining the fee includes:

  • Does the transaction fill the requirements? Some companies only finance certain types of products or require a minimum transaction amount.
  • Is your customer creditworthy? Your customer’s business credit history is a key consideration.
  • Is your supplier reliable? Lenders prefer to finance orders from established suppliers with no financial problems.
  • Is your company qualified? The lender may review your financial statements, supplier and client contracts and information available in public records to determine if the business is able to execute the order.
  • Do the company owners qualify? Lenders prefer to work with business owners with relevant experience and no legal problems.

Alternatives to PO financing

If purchase order financing isn’t right for your business, consider the following alternatives:

  • Invoice financing. Invoice financing is a form of asset-based lending that allows businesses to borrow against the accounts receivable they have outstanding. This type of financing can be a great option for businesses that have healthy revenues but need a short-term loan to cover a specific expense, such as paying for new inventory.
  • Invoice factoring. Invoice factoring is an alternative to purchase order financing that many businesses use to get the cash they need to run their operations. With invoice factoring, a business sells its outstanding invoices to a factoring company in exchange for a lump sum of cash. This can be a great option for businesses that have a lot of invoices outstanding and need the cash quickly.
  • Merchant cash advance. A merchant cash advance (MCA) is a form of alternative financing that provides companies with an advance against future credit and debit card sales. One advantage of an MCA is that the approval process is much faster than traditional loans. In most cases, you can get the money you need in just a few days.
  • Line of credit. A business line of credit may not require any collateral and the proceeds can be used for any purpose, including purchasing inventory. This makes it a more flexible option for some businesses.
  • Term loans. A business can use a term loan as an alternative to purchase order financing. Term loans give you a lump sum of cash upfront that can be used for various purposes, and they’re often available from local banks and credit unions.
  • SBA loans. SBA loans have a number of advantages over purchase order financing. The interest rates on SBA loans have interest rate caps, so rates may be much lower than you’d pay for purchase order financing. Plus, SBA loans are guaranteed by the government, which gives lenders confidence in lending to small businesses.
 

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