What is Purchase Order Financing? How Does it Work?

What is Purchase Order Finance?

PO financing, or buy order financing, is a financing arrangement in which a third party or purchase order financing company provides funding to a supplier to fulfill a purchase order placed by a client.

PO Financing is quite similar to payday or title loans. However, the manufacture of the items covered by the PO is funded by the Purchase Order financing company. Suppose a borrower is approved for a PO loan or PO financing. This financing ensures the customer orders are fulfilled while keeping the company’s (credit) slate clean.

If you are a small business owner and are worried about fulfilling the conditions of your subsequent big purchase order. PO financing and a purchase order financing company directly may answer your worries.

A purchase order loan could pay for the whole order or only cover a certain amount. Whenever the vendor is prepared to send the goods, the financing firm for the purchase order will collect the money from the buyer. Your firm will get a net amount due after the financing company deducts its fees.

It would be ideal for suppliers if large purchase orders never required financing. That is not always the case, however. It’s excellent news for small businesses that supply chains may expand and meet demand with the help of PO loans for funding purchase orders.

Contrarily, the purchase order financing companies will provide funding to suppliers despite their low credit ratings. When considering a loan application, these financial institutions care more about the reliability of the small businesses that submit purchase orders.

Furthermore, obtaining a loan through a conventional financial institution might take a long time (if you qualify). In contrast, PO loans from purchase order financing companies are far quicker and simpler to acquire. This is particularly helpful for younger small businesses that may be surprised with a huge purchase order when they are unprepared to handle it.

How Does Purchase Order Financing Work?

A standard small business loan consists of only you and the lending institution.

However, when you get into a purchase order finance deal, you will normally work with the following individuals:

Your Business (As You will be the Borrower)

You, the company buyer in need of funding to complete an order.

The Purchase Order Financing Company

The funding provider firm. Your order is validated, and payment is made to the vendor by this business.

Third-Party Supplier

The company or person from whom you get the products you then resell or distribute. The purchase order financing firm pays the Supplier directly for the items.

Your Customer

The person or company wanting to purchase your wares or customer. After the business receives the products, the client in a purchase order financing agreement normally makes payment straight to the finance business.

This is how to purchase order financing agreement functions:

Step 1: Start with the Paperwork and Application for PO Financing

The first stage begins with an application and accompanying paperwork sent to the financing company. The following are some of the standard requests made by financial companies. However, the specifics may vary from business to company:

• Supplier details and purchase order copy
• Subsequent records of a comparable deal in the past
• Budget analysis of payables and receivables

If the deal goes through, a contract is signed, and the process of securing financing begins.

Step 2: Payment to the Supplier

The financing firm will wire funds to your vendor in advance. Be aware that a traditional financial institution never sends money to a foreign vendor in advance via a wire transfer.

Instead, a letter of credit or another similar document is used to pay the provider. In international trade, these tools are often used. With a letter of credit, you may be certain that your provider will be paid for their services regardless of whether or not you pay them.

Payment may be delayed if a US or Canadian supplier is small or has a bad line of credit. If the gross margin of the transaction is at least 30%, finance firms will often pay up to 100% of the supplier cost. Client contributions may be necessary for lower gross margin transactions.

Step 3: Third-Party Company will inspect your Goods

Having a third-party inspection firm like SGS check out your items is a requirement of most financing providers for Purchase order funding.

The inspection serves to verify that the Supplier’s output conforms to the standards mentioned in the purchase orders. Products are often inspected just before shipping.

Step 4: The Product Delivered to the End-Customer

Products are supplied to the buyer after passing inspection. The ultimate consumer usually conducts their check to ensure they have gotten what they ordered.

Step 5: Now, the Invoice will be sent to the End Customer

A sales invoice is sent to the buyer. Now that you’ve promised the goods or services, it’s time to collect money from your consumer. There are two potential outcomes to the deal. The decision to factor in the Invoice or not is yours to make.

• Suppose you decide to use a factoring service. In that case, they will determine the advance amount, pay off the PO financing line with the funds, and send the remainder to your business. In the future, the deal will be handled in the same manner as any other invoice factoring deal.
• No action is required if you decide against using factoring. Fees will be assessed on the transaction based on the PO financing rate.

Step 6: At Last, End-customer will initiate the Payment

If the Invoice was factored, the factoring business is responsible for collecting payment. After deducting the factoring charge from the Invoice, your business will get the leftover monies.

Settlement for unfactored outstanding invoices is handled by the finance attached to the corresponding purchase orders. After deducting the amount, it advanced and its costs, the PO financing company directly provides the remaining balance to your business.

Who uses Purchase Order Financing?

Purchase order financing is useful for companies that buy items from other companies for resale. To put it another way, you won’t have to worry about keeping your cash locked up in pending orders, so you can focus on expanding your company and bringing new consumers on board. Several Illustrations Could Be:

Importers or Exporters of Finished Goods

The high cost of transporting goods is problematic for both importers and exporters. By obtaining a cash advance to cover the cost of an order, customers may avoid having their cash held up in escrow. At the same time, they wait for their merchandise to arrive.

Wholesalers

Profiting from rising consumer demand doesn’t need wholesalers to drain their resources or sit on unsold stock. When they have a customer already, wholesalers may reduce some of the risk associated with stocking commodities by small business financing the procurement and transport of those products.

Distributors

Distributors may save money initially while still satisfying customer demand for high-margin items, even during peak seasons. Distributors may keep more stock on hand and lower their transportation expenses with PO financing and financing companies, which frees up more of their investable working capital.

Outsourced Manufacturers

Suppose an outsourced manufacturer is low on cash but seeing great demand for their goods. In that case, purchase order financing may answer their financial woes. You may reinvest in the firm and pay for the supply and delivery of items instead of using all of your cash in the production process.

Resellers

When a retailer opens its doors, it may need to use its working capital on necessities like rent and payroll rather than inventory. Instead of putting money in stock, the reseller may take on more consumers with the help of purchase order financing.

How Much Does Purchase Order Financing Cost?

Fees for financing a purchase order are normally set per 30 days, ranging from 1% to 6% per month by financing companies. These percentages are applied to the total amount owed by the buyer, and they rise the longer it takes for them to pay.

While the upfront costs may appear reasonable, the full cost of the financing may only be determined by converting the fees into an annual percentage rate (APR). The annual percentage rate (APR) for the best purchase order finance is often over 20%.

There is a possibility that the financing company for your purchase order will utilize a rate structure in which you pay a flat rate for the first 30 days and then a decreasing rate for the remaining days until your client pays in full.

Small business owners may, for instance, begin charging interest rates at 3% every 30 days, then increase that rate to 1% per 10 days, and finally, to 0.10% per day.

Factors like your company’s qualities, customer’s creditworthiness, line of credit, and your Supplier’s standing will influence the purchase order financing costs business owner obtain.

Pros and Cons of Purchase Order Financing

Cash flow problems may be resolved via the use of PO Financing and financing companies. It opens up the possibility of a small company fulfil the order they otherwise couldn’t.

However, not every business will benefit from purchase order financing. For instance, companies with slim profit margins may have to explore additional sources of capital. The Pros and Cons of Using Purchase Orders to Fund Your Business

Advantages

They provide Flexibility

Even though it involves borrowing money, purchase order financing is not a loan. A small business owner can always turn your open purchase orders into cash if you have financial difficulties. Additionally, business owner may get a loan for all their expenses without having to worry about making monthly payments.

PO financing is more transaction-focused and flexible than a long-term commitment like repaying a bank loan or SBA loan over many years in manageable chunks of money. It helps in business line growth too!

You do not need to provide a personal guarantee

Commonly, a personal guarantee is required when a firm borrows money with asset-based lending. This implies that the lender may confiscate your personal assets if the company cannot repay the debt. Non-recourse invoice financing is a good option for certain POs. The lender takes on the risk if the buyer can’t pay for the products. Each financial institution is different in this regard.

It is very easy to qualify

Suppose a company owner has trouble getting a loan authorized promptly. In that case, purchase order financing may be a viable option. Loans based on purchase orders are often simpler to get. You may use the purchase order as security for a loan.

The Idea of PO Financing is great for startups

A bind is a common financial situation in which startup founders find themselves. They are in a period of fast expansion but have a hard time attracting investors since they have yet to prove their worth. The development potential of an NBFC might be severely damaged if the firm declines even a single order from a client. Retaining a happy client base and fortifying your company’s cash flow is possible with purchase order financing.

Disadvantages

You may lose control over the delivery

When you use buy order financing, the finance business handles several tasks, such as making payments to suppliers and collecting due payments from clients. You don’t have any control over the delivery of the items since the Supplier sends them straight to the client. While this might save time for your company, it also runs the risk of not having procedures handled in the manner you’d want. This could put your relationships with vendors and customers in danger.

It could be too expensive

Although the monthly expenses associated with purchase order financing (usually between 1 and 6 percent of the total supplier costs) may appear little initially, they may quickly add up to a substantially larger annual percentage rate (APR). Based on anecdotal evidence, they may range from 20% to 50% or more.

You may have to keep reliance on customers

The entire cost of purchase order financing is hard to predict in advance since the fees you pay are tied to the time it takes your client to pay their order Invoice. In addition, the customer’s creditworthiness and the approved credit limit of your consumer line of credit are major determinants in whether or not you are approved for PO financing.

How to Get Purchase Order Financing?

Finance companies found online, many of which focus solely on providing qualifying businesses with purchase order financing, are a common place to start looking for such a loan. While some banks may provide purchase order financing for their current customers or bigger clients, this service is not often publicized or made available to small firms.

Here are a few of the greatest purchase order financing firms to consider for financing options if you’re seeking to get started on your search:

Liquid Capital

Asset-based finance options are what Liquid Capital excels at providing. With purchase order financing from liquid cash needed, you may get up to $10 million to pay for your suppliers at once. In as little as 24 hours, approved enterprises may obtain funding. The firm does not disclose the annual percentage rates and costs associated with its invoice financing, despite its claim that none exists.

They specialize in PO financing, as the name suggests, and will finance you as much as 100% of your supplier expenses (between $500,000 and $25,000,000). However, the website says you will pay “a modest portion of the profit you earn on the individual sale being financed.” The application procedure at PurchaseOrderFinancing takes an average of 72 hours to complete, and approved firms may get funding small businesses in as little as 7-14 days.

SMB Compass

Small and medium-sized businesses may apply for PO financing from SMB Compass for quantities between $25,000 and $10 million, with rates ranging from 1.5% to 3.5% and a funding duration of fewer than 30 days. In addition to traditional loan term small business loans, the firm provides inventory, Invoice, and equipment loans to its clientele.

King Trade Capital

King Trade Capital, which provides capital to small and medium-sized companies throughout the United States via purchase order financing, claims on its website to be the country’s biggest such corporation. However, curious companies may submit a financing request through the website to learn more about King Trade’s offerings after reading the brief description provided.

What are the Similarities Between PO Financing and Invoice Factoring?

Comparing buying order financing vs. invoice finance may help firms better understand their alternatives and make educated choices.

• Both aid local firms by smoothing out their cash flow cycles and reducing associated risks.
• Using them facilitates easy and rapid access to operating money.
• These forms of funding are highly recommended for startups and companies with low credit scores.
• In both cases, the customer’s ability to repay the loan is a primary factor in determining the loan amount approved.
• Lenders take consumer payments over the phone or in person. Since clients have a role in both types of finance, secrecy is impossible to maintain with non-bank lenders.

How to Choose a Purchase Order Financing Company

Before agreeing to conditions for purchase order financing, it is important to shop and evaluate the purchase order financing companies. Consider these when searching for the ideal purchase order for financial companies.

Payment Methods offered by Supplier

Finance firms specializing in purchase orders may pay their vendors through cash and wire transfers. Although letters of credit are often regarded as the safest means of payment, not all vendors will take them. Pick a lender that allows you to make payments as you want.

Consider your Minimum Annual Volume Requirements

Certain suppliers impose minimum yearly revenue or purchase order volume limitations. Choose a lender that can meet all of your requirements.

Service Provider’s Experience in Your Industry

Find a service provider that is familiar with your field and your goods. Check the finance supplier’s track record with businesses similar to yours and how long they’ve been in operation.

Focus on the Available Services

Select a firm that focuses only on purchase order financing rather than one that provides this service with invoice factoring and other options. For instance, some traditional banking institutions focus on providing just conventional corporate loans or modest personal loans and may lack the resources necessary to interact directly with suppliers.

Borrower Requirements

Your or your customer’s creditworthiness could be checked by the service you’re applying for. Yet, a borrower’s creditworthiness may be evaluated more heavily based on their payment history. If the consumer doesn’t pay their bill, you could have to guarantee advance payment with your own money.

Keep in mind the Overall Cost of Financing

Evaluate the processing and setup costs, in addition to the monthly loan fees, imposed by each financing company. It’s also a good idea to learn whether late payment fees are added if customers wait too long to pay.

Conclusion

Cash-strapped expanding firms, as well as seasonal enterprises, may benefit greatly from purchase order financing. We hope this primer was useful in helping you evaluate whether or not this kind of financing is best for your company.