Lack of cash is a persistent issue that plagues many small and medium-sized businesses (SMBs), and it’s a struggle that we, at FundThrough, understand all too well. As entrepreneurs and finance leaders ourselves, we’ve been there. We understand how difficult an challenge this is, which is why finding the right financial solution is crucial to sustaining and growing a business. That’s why we specialize in invoice factoring, a flexible and fast method to address cash flow challenges. However, purchase order financing is a close relative to invoice factoring, and in some scenarios, it might be the perfect fit for you. Below, we’ll dig into purchase order financing, how it contrasts with factoring, and provide the information you need to make the best decision to improve your business’ cash flow. Whether you’re facing a new project, late payments, or seasonal fluctuations, we’re here to help you find the right solution for your unique needs.
What Is Purchase Order Financing?
Purchase order financing, commonly referred to as PO financing, is a specialized funding solution that allows businesses to obtain capital based on their customer’s purchase orders. It’s particularly useful when a company receives a large order but lacks the necessary funds to fulfill it.
Here’s how it works: A business receives a purchase order from a customer but may not have the immediate cash to produce or deliver the product. Through PO financing, a financing company pays the business’ supplier directly (or offers a line of credit) to manufacture and ship the products. Upon receiving product, the business’ customer pays the invoice to the financing company, who then takes a fee before remitting the balance to the business.
Who Uses Purchase Order Financing?
PO financing is a method of obtaining working capital for businesses that sell physical goods and need to invest in inventory. Usually, this form of financing is only available for B2B companies. Businesses that typically turn to a PO lender are distributors, wholesalers, resellers, outsourcers, government contractors, startups, importers, and businesses with seasonal cash flow.
When to Use Purchase Order Financing
Cash flow challenges can arise from various situations. For many businesses, purchase order financing offers an effective solution to these challenges, helping to bridge the financial gaps when immediate working capital is needed. Whether you’re dealing with large purchase orders, rapid growth, or seasonal fluctuations, purchase order financing may be the ideal remedy for your cash flow problems. Below, we’ve outlined several use cases where purchase order financing can be particularly beneficial, some of which closely align with situations where invoice factoring could also help:
Large Purchase Orders: If you receive an unusually large order from a client and lack the funds to fulfill it, purchase order financing can enable you to meet the demand without hindering other operations.
New Client Opportunities: Working with a new client often requires additional resources. PO financing allows you to take on new clients and orders without worrying about immediate payment.
Rapid Business Growth: For businesses experiencing faster growth than invoice payments are coming in, purchase order financing can provide the necessary capital to sustain that growth.
Seasonal Fluctuations: Some businesses face seasonal highs and lows that can strain cash flow. Purchase order financing can help to smooth out these fluctuations, ensuring steady operations year-round.
Credit Constraints: If your business is unable to secure traditional financing due to credit constraints, turning to purchase order financing lenders might be the solution. As top purchase order financing companies often focus more on the creditworthiness of your clients rather than your business, this opens up opportunities for more companies to get funded.
Supplier Payment Demands: Financing purchase orders can be a viable solution when your own suppliers require payment upfront or on shorter terms, and your business needs to maintain cash for other operational expenses.
Through partnering with reputable purchase order financing companies, these scenarios can be addressed relatively easily. By understanding the specific situations where purchase order financing might fit your needs, you can make informed decisions to support the continuity and growth of your business.
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Rates: How Much Does Purchase Order Financing Cost?
Purchase order financing typically costs between 1.8% to 6% of the total purchase order value per month, depending on various factors.
These rates can be influenced by the creditworthiness of your clients, the overall risk associated with the transaction, the volume of outstanding invoices, and the terms of the agreement with the financing company. By evaluating these factors (among others), purchase order financing lenders are able to determine the specific rate that will apply to your particular financing solution, making it a flexible type of funding tailored to the unique circumstances of your business.
Qualifying for Purchase Order Financing
Qualifying for purchase order financing is often more straightforward than traditional financing or small business loans. Unlike traditional lenders, purchase order financing companies typically focus more on the creditworthiness of your customers rather than your own credit history, although a significant bad credit history may still be a factor to consider. To qualify for PO funding, most financing companies will look at the following:
A Verified Purchase Order: You’ll need a legally binding and verifiable purchase order from a reputable business or government customer.
Creditworthy Supplier and Customer: Financing companies will assess the creditworthiness of both your supplier and customer, ensuring that they have a strong track record of fulfilling obligations.
Invoice to the Customer: An official invoice directed to the customer may be required, detailing the terms of the sale.
Your Gross Margin: Many lenders may evaluate your gross margin to understand the profitability of the transaction, looking for healthy profit margins that reflect a well-managed business.
Your Most Recent P&L Sheet or Balance Sheet: This provides insight into your company’s financial health, helping lenders assess the overall risk.
Type of Products or Services Involved: Some purchase order financing lenders might also look into the nature of the products or services in the transaction, favoring those with clear and tangible deliverables.
Duration of Business Operations: A history of successful operations can build confidence in your business, although some lenders cater specifically to newer types of businesses.
As a business owner, it’s essential to gather this key information and required documents to boost your chances of qualifying for purchase order funding. Unlike other forms of financing, this type of financing places emphasis on the transaction’s viability and your customer’s creditworthiness, rather than just your own financial standing. This makes purchase order funding a flexible financing solution, especially when considering a cash advance against unpaid invoices or leveraging accounts receivable. It’s a useful solution for situations where you need more cash on hand.
How Does Purchase Order Financing Work?
1. Apply for Purchase Order Financing:
Submit an application to the purchase order financing company, providing necessary documents such as the purchase order, bank statements, and any relevant information. The lender will then review your creditworthiness and the supplier’s ability to fulfill the order.
2. Funds Transferred to Suppliers:
Once approved, the financing company sends the funds directly to the supplier, either in full or partial payments, to cover the costs of materials, services, and labor needed to complete the order. This enables you to fulfill orders without depleting your working capital.
3. Receive and Ship Goods to Customer:
Upon receiving the goods from the supplier, inspect them for quality and adherence to specifications. Ship them to the customer, whether directly or through the supplier, depending on the agreement.
4. Invoice and Collect Payment from Customer:
After the goods have been delivered, invoice the customer as usual and collect payment. This transaction remains between you and the customer, separate from the financing arrangement.
5. The Customer Pays the Purchase Order Financing Company:
Once the customer pays the invoice to the financing company according to the terms and conditions of the agreement. This repayment includes the principal amount plus any agreed-upon fees or interest.
The Benefits and Drawbacks of Purchase Order Financing
- Fast-Track Funding: Traditional bank loans may involve lengthy approval processes, but purchase order financing typically offers a quicker turnaround time.
- Startup-Friendly: Unlike traditional financing options (such as lines of credit) that demand an established business history, purchase order financing is accessible to startups and new businesses that meet the qualification criteria.
- Credit Score Flexibility: Businesses with lower credit scores may still qualify if the customer involved in the transaction has a strong credit profile.
- Empowers Business Growth: Helps companies to take on large-scale orders that would otherwise be out of reach, providing an immediate path for expansion.
- Potential for Full Supplier Cost Coverage: Under certain conditions, such as having a specific gross margin percentage, this financing option can cover the entirety of the costs you owe to suppliers. This is particularly beneficial for under-capitalized businesses.
- Higher Fees: Often more expensive than other financing options, including invoice factoring.
- Less Than 100% Financing: While some providers may offer close to 100% financing for purchase orders, it’s rare. Businesses often need additional funds to cover the full amount of the purchase order.
- Not Available for B2C Organizations: Exclusive to B2B transactions.
- May Require Strong Supplier Relationships: Dependence on supplier’s ability to fulfill orders.
- Limited to Tangible Products or Clear Deliverables: May not be suitable for all types of businesses.
Purchase Order Financing vs. Factoring: Why Factoring Makes Sense
While both Purchase Order Financing and Invoice Factoring offer ways to access working capital, they serve different purposes and business needs.
Invoice factoring is when you sell your unpaid invoices to a factoring company in exchange for immediate cash, typically covering the majority of the invoice value. Unlike purchase order financing, which provides funds based on a confirmed purchase order to pay suppliers, invoice factoring focuses on already generated invoices to speed up cash flow from sales already made. While purchase order financing is ideal for businesses needing upfront capital to fulfill large orders, invoice factoring serves companies seeking to manage and improve cash flow by quickly converting outstanding invoices into liquid assets.
In comparison to purchase order financing, invoice factoring offers more versatility in how funds can be used, is open to more types of businesses and situations, and can be more cost-effective. For businesses who are unsure about whether to choose invoice factoring over purchase order financing, here are a list of invoice factoring advantages to consider:
1. Quicker Access to Funds: Purchase order financing is a rapid solution, but invoice factoring is typically even faster— offering funding within days.
2. No Limit on Funding: With FundThrough, invoice factoring provides unlimited funding based on the size of your invoices, whereas purchase order financing may have limitations based on the value of the confirmed purchase orders.
3. Transparent Pricing: With FundThrough invoice factoring, you receive 100% of the invoice amount minus a single, upfront fee, making it straightforward. Purchase order financing may include various fees and interest rates.
4. Greater Flexibility: Invoice factoring allows you to choose which invoices to factor, providing more control over your cash flow. (At least with FundThrough!) Purchase order financing is restricted to specific orders.
5. No Long-Term Contracts: Invoice factoring with FundThrough doesn’t require a long-term contract, allowing you the freedom to factor invoices only when you need to. And your obligations are over after your customer pays the invoice. Purchase order financing might come with more contractual obligations.
6. High-Level Customer Support: Dedicated FundThrough account managers for invoice factoring provide personalized, responsive support throughout the funding process. This level of support may not always be available with Purchase order financing.
7.Progressive Technology: At FundThrough, the use of streamlined, AI-powered processes and integration with popular accounting softwares makes the entire funding process more efficient compared to the often manual processes involved in purchase order financing.
When seeking the best purchase order financing company for your business, you’ll want to carefully evaluate various factors to find a partner that aligns with your unique needs and industry requirements. Consider the following aspects:
- Industry Experience: Does the company have experience working in your specific industry? A seasoned provider can offer valuable insights tailored to your sector.
- Rates: What interest rates or fees are charged? Competitive pricing is essential to maintain your profit margins.
- Funding Limits: Understand the financing limits and how they align with your typical order sizes.
- Ease of Application Process: A streamlined application process can save you time and reduce stress.
- Ease of Getting Funded: How quickly are funds advanced? Timeliness may be crucial for your operations.
- How They Work with Your Customers and Supplier: Assess how the company communicates and collaborates with both your customers and suppliers. They should act as a seamless extension of your business.
- Customer Service to You: Evaluate their support and responsiveness to your inquiries and needs.
Just as with purchase order financing, choosing the right factoring company requires careful consideration. When evaluating a factoring company, you can follow a similar approach. At FundThrough, we pride ourselves on offering the following advantages:
- Flexibility: You don’t have to fund all your invoices; you can choose which ones to fund.
- Speed: Quick approval and funding to keep your operations running smoothly.
- Unlimited Funding: Our funding solutions can grow with your business, with no arbitrary caps.
- 100% Advance Rates: Receive the full amount upfront, providing maximum liquidity.
- Ease of Funding: A user-friendly process designed for simplicity and efficiency.
You’re not alone on this quest to identify the best company for your needs. There are numerous reputable companies like SouthStar Capital and SMB Compass who can help guide you through the world of purchase order financing. So take your time, dive deep into your research, and read those reviews. With the right partner by your side, you can feel confident that you’re making a smart financial move for your business.