Consider PO Financing to Help Your Business Grow
An increase in purchase orders is a positive development for most businesses — proof that customers are interested in, and buying, their products. At the same time, rising sales can prompt a cash crunch. Some companies, especially smaller, growing firms, may lack enough cash to pay their suppliers and fill new orders — often because they’re waiting to be paid for previous sales. This is where purchase order financing, often referred to as “PO financing,” can help.
How it works
Most businesses that use PO financing sell finished, assembled goods, rather than raw materials or services. They typically sell to other businesses or government agencies. In PO financing, the purchase order(s) act as collateral for a loan.
Here’s one example: Suppose you receive an $80,000 purchase order from a customer for 100 widgets, but you lack the inventory to fill it. You connect with your supplier to determine the cost to get 100 widgets. Your supplier says it will be $50,000. But you don’t have $50,000 cash in hand.
So, you apply to a lender — typically, a specialist in purchase order financing — who reviews your application. Assuming the lender accepts your application, it then offers to cover some or all of the costs of filling the order.
PO financing generally applies only to the cost to fill the order — in this case, the $50,000 the supplier is requesting. The funding company says it will advance 80% of the $50,000, or $40,000, to your supplier, at a fee of 3% per month. Your business must cover the remaining $10,000 the supplier needs to fill the order.
The financing company sends $40,000 to the supplier, and your business sends the other $10,000. The supplier manufactures the goods and sends them directly to your customer. You invoice the customer for $80,000 and also send the invoice to the PO financing company.
In 30 days, the customer pays the financing company $80,000, or the amount of the invoice. The financing firm deducts its fee of $1,200 ($40,000 multiplied by 3%) along with the $40,000 it’s already sent to the supplier. It then sends your company the $38,800 that remains.
Pros and cons
On the positive side, PO financing can help businesses accept orders they might otherwise have to decline. This can be particularly helpful to businesses that are growing quickly, as well as to those whose sales are seasonal, leading to periods in which working capital is tight.
Also, because PO financing companies tend to look at the creditworthiness of your customers and suppliers, it can be easier to qualify for this type of financing than for other types of funding.
On the flip side, PO financing can be expensive. Generally, the longer your customer takes to pay, the higher your financing fee will be. Some lenders offer PO financing only on larger orders.
In addition, in many PO financing transactions, your supplier ships directly to your customer, and your customer pays the financing company. As a result, your customer will become aware of your need for financing.
Due diligence
If you think PO financing might be right for your business, you’ll need to find the right lender. First check a candidate company’s experience both with this type of financing and with your industry. Then find out, among other information, its usual financing fees, the portion of the purchase order it typically finances and what happens if your customer fails to pay.
You’ll also want to know how the financing company will pay your supplier. Many use a letter of credit, which typically states that payment will be made once specific provisions are met. For instance, a provision might state that the financing company must receive verification that the products have been shipped before it will pay.
Determining what’s best for your business
Is PO financing a viable funding option for your business? It’s important to carefully assess all the pros and cons and thoroughly vet the PO financing company before you go forward. Your accounting professional can help you weigh the risks and rewards and determine the best financing methods to keep your growing business profitable.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
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