Purchase Order Loans vs. Small Business Loans: How to Decide
Two popular—but very different—options are purchase order loans and small business loans.
Both purchase order and small business loans can be hugely beneficial, but only if they’re used strategically. To ensure you choose the right option, this post will compare and contrast purchase order funding and small business loans.
To ensure we’re on the same page, we’ll start with a quick review of purchase order financing. You can also review the definition of small business loans in this post.
What is Purchase Order Financing?
Purchase order (PO) financing is a type of funding that businesses use when they receive a customer order that they don’t have enough cash to fulfill. It enables them to make large purchase orders, even if they’re having cash flow issues.
Here’s how purchase order financing works:
- The purchase order lender pays your supplier for the cost of fulfilling your customer’s order.
- Your supplier delivers the products to your customer and you invoice the customer.
- Your customer’s payment goes directly to the purchase order financing company who deducts their fee and passes payment on to your business.
Depending on the lender, your supplier’s reputation, and your customer’s credit, PO financing typically covers 80 to 100 percent of the purchase order cost.
Small Business Loans vs. Purchase Order Financing
Despite their different structure, many entrepreneurs have used both small business loans and PO financing to great effect. To help you determine the best fit for your business, the following section will compare PO financing and small business loans based on:
- Application process
- Eligibility requirements
- Use of funds
Generally speaking, you can obtain purchase order financing much more quickly than you can a small business loan. Traditional small business loans from a credit union or bank can take a month or more. However, alternative options, such as online lenders, can accept, process, and approve your application in just a few days.
In fact, with an existing online lender relationship, application for a small business loan may be as quick as it is for PO financing. All that said, both PO financing and small business loans usually require extensive documentation.
With a small business loan, the lender’s main concern is that you can repay the loan. So your eligibility requirements will center around your creditworthiness, business history, revenue, and debt load. Depending on the type of small business loan, you’ll need to have a good credit history, at least a few years in business, and a debt-to-income ratio around 36 percent or lower.
PO lenders are about much different factors than small business lenders. PO lenders want to ensure the sale is sufficiently large, the supplier can fulfill the order, your customer can pay for it, and the order is non-cancelable. According to BizJournals, the minimum requirements to qualify for PO financing are:
- Creditworthy supplier and customer
- Profit margins 15 percent or higher
- Must have business or government customers (B2C not eligible)
- Must sell tangible goods
Use of Funds
Entrepreneurs can use small business loans for a variety of expenses including inventory, equipment, administrative costs, marketing, expansions, and more.
Small business lenders charge you fees and interest based on fixed or variable interest rates, while PO lenders only charge fees. PO financing fees vary but they are structured based on a set percentage of the funds you owe your supplier.
For example, suppose you owe your supplier $100,000, the PO financing firm would charge you between 1 and 6 percent of that $100,000 every 30 days. As you can see, the amount you pay on a purchase order loan depends on when your customer pays. Still, if you convert the PO financing costs to an annual percentage rate (APR), it’ll usually be higher than a small business loan’s APR.
Conclusion: Which Loan Option is Right for You?
If you need to fund anything other than a purchase order, small business loans are a better option than PO financing.
After all, the only thing you can finance with PO financing is a purchase order. However, if you need working capital to finance order fulfillment or have cash flow problems, both purchase order and small business loans can work.
Purchase order financing is faster but typically more expensive. Also, if your credit isn’t sufficient to qualify for a small business loan, you may still qualify for PO financing.
All that said, if you can qualify for a small business loan and its application is fast enough, that’s probably the best route for you.
Therefore, if your credit score is bad, or you can’t get approved for a small business loan quickly enough, a PO loan may be a financing option worth considering.
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.