Purchase order financing is a unique financial product that can help your business take on large orders that it may otherwise not be able to fulfill. It is easy fast, flexible, and easy to qualify for. PO financing provides a cash advance before you invoice your customer, providing the necessary funds to procure necessary material or pay your vendors so you can fulfill a large purchase order.
How does purchase order financing work?
The process of financing a PO is simple. It begins with your securing a new account, or a large order from an established customer. Once the order is received, the purchase order financing company will advance the necessary funds to acquire the goods/materials that are required to fulfill the order. This is paid directly to your vendor. When your customer receives their purchase order and pays the bill, the transaction is settled.
What are the advantages?
- Easy for new businesses to obtain
- Based on your suppler’s and customer’s credit
- Quick access to capital allows you to grow your business
- Easier and faster to obtain than a business loan
- Can be a transactional product (like spot factoring) – Only use when needed
What are the disadvantages?
- High interest rates when compared to traditional loans
- Only able to receive funds for goods or services that are required to fulfill the PO
- High profit margin required to qualify
- Only available for businesses that sell a tangible finished product, not services.
Who uses purchase order funding?
Because it is so flexible and easy to qualify for, PO funding is used by many businesses of all shapes and sizes. They include:
- Startups/New entities
- Large and established businesses
- Government contractors
How do you qualify?
PO funding is much easier to qualify for than a business loan. The due diligence process performed by your funding company is very similar to what most factoring companies will look into.
There is usually a minimum purchase order amount that your provider will require. This varies greatly between companies, but you can generally expect them to require a $50,000 minimum. There are some that will go lower, but with added expenses.
Your provider will also expect a certain gross profit margin. This too varies between companies. A gross margin of 20-25% or higher is what they generally look for.
Other transactional factors
While the financials are usually the most important part of qualifying, there are a few other things to keep in mind when determining if you qualify for PO financing.
- The order must usually be non cancel-able
- There must not be a consignment or guarantee of any sort involved.
Your customer requirements
Purchase order funding is based on your customer’s creditworthiness, and not your businesses. If it is the first time that you are financing a PO from a particular customer, the purchase order financing company will perform the necessary due diligence to qualify them. Once this initial setup is performed, the client will already be qualified for any future purchase orders.
They also strongly prefer orders from large established companies, or government entities.
Your supplier requirements
While your supplier’s creditworthiness isn’t necessarily a factor in qualify them, their overall business performance and health is taken into consideration. Your funding company will like to see a solid company with strong financials that isn’t depending on your payment in order to manufacture or ship your goods.
Your company requirements
They will also make sure your company is otherwise financially stable, and isn’t involved in any litigation or tax problems. They will also like to confirm supporting financials to confirm that you will indeed be able to fulfill the order. For startup or new companies, they will most likely look further into the owner’s personal finances before making a decision.
Purchase order financing rates
Much like invoice factoring rates, PO funding rates are higher than what you’d expect from a bank loan. This is because of their high risk and ease of qualification. The interest rate that is charged is usually based on the actual utilized amount of the invoice total. This means that you pay interest on the amount needed to pay your supplier. For example:
You receive a purchase order for $100,000. The supplier charges you $70,000 for the goods necessary to fulfill the order. The lender will advance the $70,000 to the supplier and you will pay interest only on that amount.
Typical rates are between 2-4% for 30 days. Rates are usually pro-rated by the week or day thereafter. Rates may be higher for smaller transactions or risky clients and suppliers. Because rate structures vary so greatly, it is important to perform a thorough analysis to determine the true cost when choosing a lender.
How to choose a purchase order financing company?
There are many companies out there that offer purchase order financing in their range of services. Others only focus on the product specifically. It’s important to carefully evaluate all of the available options.
Some questions to ask:
- Where do they get their money? Are they the actual lender, or do they act as a broker?
- What are the fees?
- Are there any minimums or maximums?
- How are my vendors paid?
- Am I required to commit to any minimum volumes?
- What do you look into when evaluating a deal?
If you keep these questions in mind when choosing a provider, it should narrow down the available choices until you can make the right decision for your business.
PO funding is a flexible financial product that can be obtained by many businesses. Similar to invoice factoring, purchase order financing allows a company to obtain a quick access to funds in order to grow their business when they ordinarily would not be able to, due to cash flow constraints.