PO Finance Article: Purchase Order Financing Basics
Let’s say that your company suddenly gets a big order from your best client. However, it is an order that is clearly too big for you. As an owner, what would you do? If your company has a good banking relationship perhaps you may be able to tap into a line of credit or a bank loan. However, what happens if your company is small or new and you have no significant banking relationships? Do you turn the customer away and let the competition handle their order? Fortunately, you don’t have to! Purchase order (PO) financing can help you secure the sale and deliver the order.
What can purchase order funding do for you?
Purchase order funding is a tool that helps you finance your large orders. It provides the necessary funding to fill large orders that otherwise you could not afford to deliver. When used correctly, it can empower you to grow your company quickly
As opposed to bank financing, purchase order funding (offered by a factoring company) does not rely on your company’s financial strength. Rather, it relies on the strength of your customers. This is a critical feature for growing companies and means that if you sell products to large companies or to government entities, purchase order funding can be the ideal option to finance those sales.
Who is a good candidate for purchase order financing?
To qualify for purchase order financing, you must sell products/goods rather than services. An ideal candidate for this type of funding would be a product reseller or distributor who is buying products from a supplier and then shipping the products to the client. Purchase order financing can also work in situations where products are sold in conjunction with services (e.g. maintenance), however, the product part of the order must be separate from the services component.
The business case for purchase order financing
PO financing is simple to use. The po financing company buys the products from your suppliers in your name, using a letter of credit or similar instrument. Then, it ensures that the products are properly delivered to your client. Once the order is delivered and approved by your client, the funds from the letter of credit are released to your supplier.
At this point, the order has been delivered and an invoice is issued. Most invoices take 30 to 60 days to get paid. Once an invoice is paid, the transaction between the parties is settled. It is common to combine po financing with receivables factoring because this enables you to reduce the total cost of the transaction.
Receivables factoring (also known as invoice factoring) is a type of financing that provides you with financing based on your receivables (or invoices) for delivered products. Usually, once an invoice is generated, the invoice is factored and the funds are used to close the po financing facility. This is done because the rates for po funding tend to be higher than the rates for factoring receivables. This little trick can help you save money and realize greater profits.
Although po financing is a great tool, it does not work for every company. However, if you have margins of at least 20% and good paying customers, you should be able to benefit from it.
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