Purchase Order Financing: How It Works, Rates and Terms
Table of Contents
- The Definition of Purchase Order Financing
- How Does Purchase Order Financing Work?
- P.O. Financing Example
- Who Can Benefit From P.O. Funding?
- Pros and Cons of Purchase Order Finance
- How Much Does Purchase Order Financing Cost?
- Purchase Order Financing and Factoring
- Working With a Purchase Order Financing Company
Did you get a large order but need more working capital to fulfill it? Don’t worry, you are not alone. Often, a company’s greatest challenge is not sales or production but simply locating the financing required to pay suppliers. Luckily, there’s an accessible financing solution that can help you accept that nice contract.
With purchase order financing, you can get up to 90% of the cost of goods necessary to complete an order.
This article will detail everything you need about this popular funding product.
Important note: If you are seeking purchase order (P.O.) funding, please be aware that we do not offer standalone purchase order funding services. Instead, we require your business to factor the invoice once the supplier has delivered the order. You can learn more about this type of service later in this article.
What is Purchase Order Financing?
Purchase Order Financing is a commercial finance transaction in which a financial company advances money to a business’ supplier to cover the costs of a purchase order placed by a business’ customer.
P.O. financing companies advance between 70 to 100% of an order amount. After paying the vendor, they wait until the customer pays to recover the funds and deduct their fees.
It is very common for a P.O. finance arrangement to transition into an invoice factoring transaction right after the goods are delivered. We’ll discuss P.O. funding and receivable factoring later in this document.
How Does Purchase Order Financing Work?
Four different participants take part in a P.O. funding transaction:
- Your business
- One of your customers
- One of your suppliers
- A purchase order financing company
Here’s how the P.O. funding process works
- You get a purchase order from a customer and an estimate from your supplier and contact a P.O. finance company.
- The P.O finance company checks the creditworthiness of your client and supplier.
- If approved, the creditor advances your supplier 70 to 100% of the purchase order cost.
- Your supplier delivers the order.
- You issue an invoice to your client.
- The customer sends the payment to the P.O. financing company (or gets payment terms, and you factor the invoice – details in the factoring section below).
- The P.O. financing company receives the money, discounts its fees and amount paid to the supplier, and sends the balance to your bank account.
Purchase order financing example
Building Contractor Inc. wants to buy some electrical outlets you distribute and has placed a purchase order for $100,000. You contact your supplier, Electrical Manufacturer LLC, and get an estimate for $60,000. Unfortunately, you don’t have enough working capital to cover those goods’ costs.
- You contact a purchase order finance company and request financing.
- The P.O. financing company evaluates the order and assesses your client’s financial background and credit history. Then, it does the same with your supplier. If the analysis is satisfactory, the financing is approved.
- Your business signs a P.O. financing agreement with the financier, including the following terms:–Amount financed: 80% of the estimate. You need to cover the remaining 20%. Fees: 4% every 30 days.
- The P.O. financing company issues a letter of credit or a vendor guarantee to Electrical Manufacturer LLC.
- After a 30-day wait, the products are delivered to Building Contractor Inc.
- The P.O. financing company pays Electrical Manufacturer $48,000, and you pay the $12,000 balance.
- You send Building Contractor Inc. an invoice.
At this stage, two things can happen:
- Your customer immediately pays the P.O. financing company. We’ll keep explaining this option in this example.
- Or you give your client payment terms (e.g., 60 days from invoice date) and use invoice factoring to cancel the 80% advance and get financing until the customer pays. You can read more about how this process works later in this document.
Building Contractor Inc. pays right away. The P.O. financier receives the $100,000 payment. Then it discounts the $48,000 paid to the supplier and $1,920 in fees (4% pre-agreed) and sends you the remaining $50,080.
Who Uses Purchase Order Finance?
This service is best suited for manufacturers, distributors, or wholesalers. Service providers are generally ineligible for P.O. Funding.
The following industries and commercial conditions can benefit from using purchase order finance:
Situations
- Firms with an insufficient or bad credit history that prevents them from qualifying for bank loans.
- Small business owners need to finance customer orders and don’t have enough working capital to pay suppliers.
- Companies with seasonal sales peaks that create temporary working capital needs.
- Enterprises of all sizes when they receive unusually large orders.
- Startups in which fast growth is creating additional cash flow needs.
- In general, any organization has cash flow problems and limited access to bank financing.
Industries
- Wholesalers and distributors
- Manufacturers
- Government contractors
- Resellers, drop shippers, and outsourcers.
Benefits & Downsides of P.O. Financing
Using purchase order financing can benefit a cash-strapped business enormously, but, like most alternative financing products, it has many negatives compared to traditional funding. Here are some pros and cons for you to consider:
Advantages
- Easier to qualify than bank financing.
- P.O. financing is not a loan and does not create debt.
- No periodic installments are required.
- There is no need to manage collections.
- Prospects with low credit scores or lack financial history can get approved.
- Approval is based on the creditworthiness of your supplier and client, not yours.
- Flexible funding solution, used as needed without long-term commitments.
- No personal guarantees are required.
- Funding is provided in just a few days from approval.
- Allow small business owners to receive new contracts that they usually won’t be able to fulfill.
- Frees up working capital to be used on other projects.
- Great for small businesses, startups, and fast-growing companies.
Disadvantages
- It’s not easy to get 100% financing.
- Your clients must send the checks directly to the financing company so they will know that a 3rd party is involved.
- Service providers do not qualify.
- It can get expensive in comparison to other traditional financial alternatives.
- It can only be used to finance the purchase order you are approved for.
- Many lenders only provide finance for large orders.
- You are approved only if your client and supplier have a solid financial background.
What Does Purchase Order Financing Cost?
The following are the most common terms in P.O. financing agreements today.
Purchase Order Financing Rates
P.O. financing rates can vary considerably among providers and transactions. The most common are 3 to 6% per month, but a few providers offer terms as short as 7 to 15 days (e.g., 2% for 10 days).
Essentially, P.O. Funding is an unsecured loan, and the discount fees reflect the risk each transaction involves. Still, the costs are low in comparison to short-term alternative loans.
Amount Financed
With P.O. funding, advances are provided to cover the cost of supplies, typically between 70% and 90% of a purchase order amount. 100% finance is not impossible to get but very unusual.
Funding Speed
The first time you request financing for specific clients and providers, the transaction can take 1 to 2 weeks to fund. Repeated deals and ongoing relationships can be funded in just a few days.
Purchase Order Financing and Factoring
Our company exclusively provides purchase order funding services to businesses that commit to utilizing factoring services after the order has been delivered.
Invoice factoring is a financial transaction frequently used by businesses with weak cash flow that give their customers payment terms. Instead of waiting to get paid, the business sells the receivable to a factoring company and receives a cash flow advance. Then, the factor waits for the payment, deducts its fees, and gives the business the balance.
It’s very common for businesses to factor the invoices right after the orders are delivered because factoring is cheaper than purchase order funding. Instead of paying the typical purchase order finance fees of 3 to 6% a month while waiting to get paid, you can save money by taking advantage of the 1 to 3% invoice factoring rates.
Here’s how it works:
- The receivable is factored right after the supplier delivers the goods and the business issues a bill.
- A portion of the invoice factoring advance is used to pay off the purchase order financing amount and fees owed.
- The arrangement becomes an invoice factoring deal, financed until the debtor pays.
This strategy prevents cash flow crunches and helps you save money by considerably decreasing the amount paid in financing fees.
You can learn everything about invoice factoring and how it works here.
Working With Our Purchase Order Funding Company
We can help growing businesses finance their ability to fulfill purchase orders. We provide funding to buy materials and finished products, pay workers, or any other input needed to complete the sale and generate an invoice.
Our purchase order funding solutions come in two forms. We can either guarantee payment directly to the vendor or establish a line of credit with the vendor. In either case, we help cash-strapped businesses get the materials they need to meet their clients’ demands.
NOTE: We don't provide standalone purchase order funding services. Instead, we require your business to factor the invoice after the supplier delivers the order.
Our P.O. Funding Services
We offer purchase order funding for transactions between $50,000 and $250,000. Much like our factoring solutions, we base purchase order funding approvals on your client’s ability to pay the invoice. That focus allows us to offer funding to a broad base of businesses.
We can provide letters of credit and vendor guarantees. Don’t forget the comfort of knowing you have a reliable resource to fulfill those contracts.
- Benefits are immediate with our purchase order funding solutions
- Helps ensure timely delivery
- Builds credibility with suppliers
- Increases market share
Never Say No to a New Order. Call our toll-free phone at 1-855-424-2955 today. We’d love to show you what we can do for you.
Author Marc J Marin