Should Your Business Consider Purchase Order Financing?
Filling numerous orders at once can be difficult, but you shouldn’t turn anyone down because that will harm your bottom line or reputation (and we all know that reputation means everything in business). However, if you have open purchase orders on your books, you might be able to pay your suppliers through purchase order financing. While it’s not the most appealing option for business owners, purchase order financing enables you to keep cash flow moving so you can meet your clients’ needs.
What is Purchase Order Financing?
Let’s say that you receive a large order from one of your clients, but don’t have the cash on-hand to pay the supplier for necessary materials. Instead of turning down the order and losing out on a sale, you can apply for purchase order financing. With this type of financing, you can get funding from an invoice factoring company to pay your supplier for the materials needed to fulfill the order.
Purchase order funding usually involves four parties: the seller/borrower (you), the lender, the supplier, and the customer. The lender will give your supplier between 80 to 90 percent of the funding for the materials, with the remainder provided by you. Once the supplier completes production and ships the customer’s order, you can invoice the customer and have them pay back the lender.
Then, after the lender receives payment from your customer, they take out their fees and return the rest of the money back to you. The order is now complete and both supplier and customer are happy!
What Are the Benefits of Purchase Order Financing?
If cash flow is keeping orders from being completed, purchase order financing might be your best bet to keep business moving. Below, we’ll list a few notable benefits of receiving financing from a PO financing company.
- Easy application process– A lender offering purchase order funding won’t require a stellar credit score or six-figure sales numbers. Instead, the purchase order financing company will be far more interested in your customer’s financial history, because the customer will pay the bill. Since no personal guarantee is needed it’s a great option for startups with little business history.
- No long-term commitment– Unlike an SBA or bank loan, a purchase order financing agreement won’t come with a long repayment plan since it’s actually not a loan. Purchase order financing is an advance from the lender to your supplier, who in turn gets paid when the order is shipped and invoiced. The entire process is usually completed within 60 days, making it a form of short-term financing.
What Are the Drawbacks of Purchase Order Financing?
Does purchase order financing sound beneficial to your business? If the answer is yes, you should still consider this list of potential drawbacks before applying.
- Purchase order funding can be expensive compared to other options– A purchase order financing agreement could cost the borrower upwards of 6 percent per month, which is much higher than the rates on SBA or loans from alternative lenders. It’s cheaper than invoice factoring or merchant cash advances, but still comes in on the pricey side of lending.
- Your business must sell tangible goods– To qualify for this type of funding, your business must sell products or items, not services. For example, a company that manufactures computer parts would eligible for this type of working capital, but a financial consulting business wouldn’t.
- You’ll need to have profit margins plus customer credit– Your company must have profit margins between 15 and 30 percent, depending on the lender. Also, your supplier and customer will need to have strong credit and have no history of bankruptcy or missed payments.
Conclusion: Is Purchase Order Financing Right for Your Business?
If you have cash flow problems and need an advance to pay suppliers, purchase order financing could be a good investment for your company. It isn’t meant to be a long-term funding solution, but if your business lacks creditworthiness and you need capital to complete orders, then purchase order financing is one way to solve your problem.
However, you should check your eligibility for SBA loans or other inexpensive financing options before considering this one. Purchase order financing isn’t a last resort, but you might save more money elsewhere.
Editor’s Note: This post was updated for accuracy and comprehensiveness in August 2019.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.