Should Your Business Consider Purchase Order Financing?
Filling numerous orders at once can be difficult, but you shouldn’t turn anyone down and harm your bottom line or reputation (because 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 will keep cash flow moving so you can meet your clients’ needs.
What is Purchase Order Financing?
Let’s consider an example to start. Let’s say that you have an open purchase order from one of your largest clients, but don’t have the cash on-hand to pay the supplier for materials. Instead of turning down the order, you can apply for purchase order financing. With this type of financing, you can get funding from a lender to pay your supplier for the materials needed to complete the open order.
Purchase order financing usually involves four parties: the seller/borrower (you), the lender, the supplier, and the customer. The purchase order financing 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 materials to the customer, you can invoice that customer and have them pay back the lender. Once the lender receives payment, 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!
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. Here’s a few notable benefits of using this type of financing:
- Easy application process – A lender offering purchase order financing won’t require a stellar credit score or six-figure sales numbers. No, the lender will be far more interested in the finance of YOUR CUSTOMER since that’s who will be paying the bill. No personal guarantee is needed, so 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.
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 Financing 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 – You must sell products or items through your business, not services. A company that manufactures computer parts would eligible for this type of funding; a financial consulting business would not.
- 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 might be creditworthy and have no history of bankruptcy or missed payments.
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’s certainly not a long-term 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.
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.