What Is Purchase Order Financing?
Purchase order financing occurs when a financing company directly pays a company's suppliers for the costs of goods sold.
Purchase Order Financing Overview
Purchase order financing (PO Financing) is a short-term business finance option where a financing institution directly pays the suppliers for goods that you will distribute to customers. It allows businesses with little working capital to accept unusually large orders while not depleting cash flow. Up to 100% of purchase order costs can be financed.
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How Purchase Order Financing Works
The funds from PO financing may not be used for anything other than buying the goods specified in your customer’s purchase order. It is designed for growing businesses that want to fulfill large orders but have little access to working capital or have poor cash flow.
If your business has a need for cash to make purchases from suppliers so you can fulfill your customer’s orders, then PO financing is a good option. Specifically, the following types of businesses are good candidates for purchase order financing:
- Retail / Wholesale businesses
- Import / Export businesses
- Distributors
- Manufacturers
There are at least four different parties involved in a purchase order financing transaction:
- Borrower - the business in need of financing
- PO financing provider - the company who provides the financing
- Supplier - the company that supplies the goods to the borrower for reselling or distribution
- Customers - the customers of the borrowers whom they directly sell the goods to
Purchase Order Financing Process
- Your business receives a large purchase order from a business or government customer.
- You get a written proposal from your supplier on the cost of the goods that your customer ordered. If your business does not have the available funds necessary to fulfill your customer’s order, it is the time to consider financing.
- You find a PO financing provider and apply for financing. You need to provide a copy of your customer’s purchase order and the supplier’s quote.
- When your application for PO financing is approved, the PO financing provider pays the supplier through a letter of credit. This time the supplier will manufacture and deliver the goods ordered by the customer.
- The supplier delivers the goods either directly to your customer or to you, depending on your delivery arrangement.
- You invoice the customer for the fulfilled order and demand immediate payment or give them net terms for settlement.
- The customer directly pays the PO financing company.
- The PO financing company deducts their fees and gives you the remaining balance.
There are external factors that can affect PO financing cost. For instance, if the supplier is slow in manufacturing and delivering the goods, you could be paying extra for the time it takes them in completing the order. Also, if the customers take longer to pay for the purchase made, the more costly the PO financing becomes.
Who Offers Purchase Order Financing?
There are two types of institutions that offer purchase order financing:
- Banks - Though they don’t usually advertise this, some traditional banks may have a PO financing services for their longstanding customers.
- Loan providers - These are online loan providers that offer AR financing and PO financing solutions to business owners
Purchase Order Financing Qualifications
Purchase order financing is a good option for businesses that meet the following requirements:
- Businesses that serve private companies and government customers (B2B and B2G)
- Profit margin must be within 15% to 20% or over
- Must sell tangible goods
- Must not directly manufacture the products being sold
- Must have suppliers with good track record for delivering quality products efficiently
- The customers of the company must have good credit record
- Must use the funds only to purchase goods to fulfill the customer’s order (as stated in the PO)
- The purchase orders are non-cancelable and have no consignment terms
Both the business’s suppliers and customers must also meet the following:
- No recent bankruptcies
- No serious legal issues
- Reputation for timely payments (customers) and timely delivery of goods (suppliers)
Overall, the two most important documentation requirements that you need to provide the purchase order financing company include:
- The completed purchase order from your customer
- The quotation from your supplier which shows all costs involved to fulfill the PO
Purchase Order Financing Costs
Although purchase order financing is a good option to get funding for huge orders from your customers, it may be an expensive type of short-term funding for your business needs. The fees vary from one provider to another, and most fees are based on the volume and risk of the transaction to the financier. Below are the typical terms and cost.
Purchase Order Financing Costs and Terms
| Amount Financed | Up to 100% of the cost of goods stated in your customer’s purchase order |
| Turnaround Time to Pay the Supplier | Around 1 to 2 weeks |
| Payment Methods to the Suppliers | Either through a Letter of Credit or via direct cash payment |
| Cost | 1.8% to 6% per month |
| Repayment Terms | Typically 60 to 90 days |
Most purchase order financing companies charge a percentage of the financed amount on the first 30 days and charge a different amount afterward. With this, the quicker the customer pays for the goods received, the less expensive the purchase order financing will be. Generally, the PO financing cost ranges from 1.8% to 6%.
It’s important to measure the cost against risk and benefits. If your company receives a huge order which your funds can’t fulfill, declining such order will negatively affect your business growth, customer relationships, and future dealings. Paying a few percentage from your profit for the financing is much better than declining the transaction and risking your business’s reputation.
Bottom Line
Before deciding whether purchase order financing is the right option for your funding needs, it’s better to look for other small business financing options first to improve your cash flow and working capital in general. If these options don’t work for you, you can then look for other purchase order financing alternatives.
The Details:
Maximum Loan Amount
Up to 100% of PO
Typical Loan Term
60 - 90 days
Typical Interest Rates
N/A
Speed
1 - 2 weeks
Down Payment?
N/A
Collateral?
Purchase Orders
Personal Guarantee?
N/A
Have a question?
Pros
Amount financed is up to 100% of cost of goods
Does not rely on personal or business credit scores
Short-term commitment only
Cons
Can be costly, depending on how efficient your suppliers in delivering the goods and how quick your customers is paying for their orders
This is a short-term solution only
Definitely not a good option if you need more funds for other business-related purposes
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Additional Resources
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