You may have heard of purchase order financing (PO), but you could be unclear as to what exactly it is and how it can help small businesses grow. However, if you are a small to medium sized business where you receive purchase orders from your customers, then you need to know what PO financing is, and how it can help.
The Commercial Finance Group offers purchase order financing in conjunction with our factoring and asset-based lending loans. Using these alternative sources of financing, you can gain access to growth capital when you need it. Below, we’ll explore the nitty-gritty of PO financing and how it could benefit your business. When it comes to alternative sources of financing, we can help. Contact us today to learn more, or visit our website to begin!
WHAT IS PO FINANCING
Purchase order (PO) financing is an alternative financing option designed to help you fulfill purchase orders when you don’t have the liquidity or cash in your bank account. PO financing occurs when you have a PO from a customer and you present that PO to a PO provider. The PO provider will advance you monies against that PO. Without PO financing, you may have to turn down an order, which translates into lost sales and lost profits. Not only is this a loss of profit, but also a loss of a potential future customer. And in small business environments word travels fast. The last thing you want is a reputation for not being to fulfill an order.
HOW DOES PO FINANCING WORK
Purchase order funding is one of the most misunderstood products in the commercial finance industry. In part, this is probably because the name is both generic and very enticing. Most companies assume that purchase order financing simply gives your company money (directly), using your purchase orders as collateral. That’s not really accurate as there is no collateral to provide as the “product” has not been made yet. Another name for this type of financing is “pre-production financing”. As a company, you are basically asking a PO provider to front the cost to make or buy the goods. If something happens and the goods are never made, there is no underlying collateral for the PO provider. That is why PO financing is expensive and considered risky for the PO provider.
Purchase order financing has very specific requirements and helps a narrow set of customers. Basically, purchase order funding helps resellers/distributors, marketing design firms that have received a purchase order exceeding their current funding abilities and need financing to fulfill it.
TYPICAL TRANSACTION STRUCTURE
Below is how a purchase order financing transaction is usually structured. Let’s assume that your customer has placed a purchase order to buy $100,000 worth of widgets. Let’s also assume that your supplier charges you $70,000 for those widgets. Additionally, your supplier wants you to prepay the $70,000 and your company does not have the money to prepay for the goods. This is where purchase order financing comes in. The financing company can help you complete this sale by structuring the following transaction (assuming you have a financing contract in place):
The purchase order financing company reviews the transaction to ensure that it complies with the funding requirements.
The purchase order financing company pays $70,000 to your supplier directly. Depending on the circumstances, payment is made by letter of credit or, if the transaction merits it, by wire transfer. Note that payment to foreign suppliers must be made by letter of credit only. Once the payment has been received, your supplier manufactures the widgets. The widgets are delivered to the customer, who inspects and accepts them.
At this point you can invoice your customer. The transaction can proceed in one of two ways. You can factor the invoice and use the factoring proceeds to pay the purchase order financing company and close the PO line. The transaction would then proceed as a conventional factoring transaction. Alternatively, if factoring is not an option, the transaction can settle once your customer pays for the end goods.
WHO IS A GOOD CANDIDATE FOR PO FINANCING
A good candidate has the following characteristics:
- You buy and then resell products without any significant modifications or customizations.
- Your company does not directly manufacture the products that you sell
- Your gross margins are at least 20%
- Your suppliers have a good track record of delivering products and are in good financial shape
- The product being sold is not “new”; in other words it has proven sales.
- Your customers have good credit
- Your purchase orders are non-cancelable and have no consignment or guaranteed sale terms
- Your orders are for a minimum of $50,000
HOW CAN PO FINANCING BENEFIT MY BUSINESS
- You don’t need good credit. However, your customer does since the factoring company or PO financing company is dependent upon payment from them.
- PO financing allows you to take on bigger orders. Taking on bigger orders can grow your business.
- PO financing allows you to grow your business without having to raise equity.
WHAT ARE THE DISADVANTAGES OF PO FINANCING
- You only get about 70% to 80% of each order. While this is can be viewed as a disadvantage, it’s better than getting 0% and if you have a 20%-30% gross profit margin, this is enough to cover your costs.
- Your suppliers will have to deal with the PO Company.
- Can be viewed as expensive compared to other forms of capital. However, when compared to lost sales or not being able to fulfill an order, the cost is more than offset and is worth the price.
If you have questions, The Commercial Finance Group can help. Contact us today!
HOW THE COMMERCIAL FINANCE GROUP CAN HELP YOUR SMALL BUSINESS GROW
The Commercial Finance Group, the best factoring company, offers ABL lending solutions, as well as factoring, including purchase order financing. Purchase order financing has a lot of flexibility that can suit your small business’ working capital needs. If you are in need of small business financing, contact The Commercial Finance Group. We’re your bridge on the road to bankability. With our working capital solutions, you’ll watch your small- to medium-sized business grow exponentially. Partner with us today!
