In recent years, purchase order (PO) financing has been gaining popularity as a tool to finance companies that have been awarded a large purchase order. In this article, we discuss:
1. What is purchase order financing?
Purchase order financing helps distributors and resellers that need funds to fulfill large purchase orders. The solution helps pay for the supplier expenses associated with the order. It enables your company to deliver the goods and fulfill the order.
Once a transaction is approved, the finance company pays the supplier directly. Foreign suppliers are usually paid with a letter of credit, ensuring they get paid only if they fulfill their obligations. The transaction settles once the end-customer receives the goods and pays for them on their usual terms. For more information, please read “How Does PO Financing Work?”
Purchase order financing has several advantages over other solutions. Here are the five most important benefits.
a) It allows you to take on new large orders
The main advantage of using purchase order financing is that your company is able to take on large orders. This ability allows you to maximize your growth
b) It’s available to new companies
Purchase order financing is available to new companies and small businesses as long as the company and the order meet the qualification criteria. This benefit is an important advantage over loans and lines of credit that are available only to established companies that have assets, cash flow, and a track record.
c) It can cover up to 100% of your supplier costs
The solution can cover up to 100% of your supplier costs, as long as your gross margin is 30% or more (this percentage varies). This benefit allows your company to fulfill a large purchase order even if the company is under-capitalized
To get an idea of the maximum amount the finance company can contribute to your supplier costs, multiply your sale price to the end-buyer by .70 (70%). For example, let’s assume your company is reselling the goods for $100,000. Multiplying $100,000 by .70 equals $70,000. The finance company can cover 100% of the supplier expense up to$70,000. Note that the 70% maximum varies based on transaction parameters.
d) The line grows with your business
The line can grow as your business grows. Unlike loans and lines of credit, your line is not constrained by your assets. The size of the line is determined by the strength of the purchase order, the credit quality of your customer, the track record of your supplier, your profitability, and your ability to execute the order. You have control over many of these variables and, therefore, over the size of your line.
e) The line can be set up quickly
A purchase order financing facility can be set up quickly, assuming that you give us a full application package. Generally, the first transaction can be funded in one to two weeks. Subsequent transactions can be funded faster. This benefit makes purchase order financing an ideal solution for companies that need quick funding.
Purchase order funding has some limitations to keep in mind. The solution is not for everyone. Here are the most important disadvantages.
a) It helps only distributors/resellers
This solution can be used only by companies that are re-selling a product. It cannot be used by companies that engage in manufacturing the products themselves. Note that using a third-party manufacturing company is usually acceptable. Companies that engage in manufacturing should consider supply chain financing.
b) It covers only direct supplier expenses
Finance companies cover only the supplier expense associated with fulfilling the order. Some finance companies also cover freight transportation costs, though that coverage varies. PO financing does not help cover other company costs such as payroll, rent, development, etc.
c) It works only in high-margin transactions
Purchase order financing works best with high-margin transactions. Generally, transactions should have a gross margin of 20%, though a higher margin is better. Note that the cost of PO financing is higher than the cost of other solutions. Consequently, companies need to monitor the effects of financing costs on their margins carefully.
4. Qualification criteria
Obtaining PO funding is easier than qualifying for conventional financing. Here are some guidelines.
a) The order must have a minimum value of $100,000
Most purchase order financing companies will only finance transactions that have a minimum value of $100,000. However, most prefer to work with larger transactions.
b) The profit margin must be at least 20%
This solution works best with transactions with a minimum gross margin of 20%, though 30% is preferred. PO financing should not be used for smaller-margin transactions due to its cost.
c) You must have a creditworthy commercial/government client
d) The purchase order must be non-cancellable
Finance companies will finance only non-cancellable purchase orders. This practice protects both the finance company and the client from situations in which an order is cancelled after a supplier payment has been made.
e) The purchase order must not be for a guaranteed/consignment sale
This solution cannot be used to finance consignment or “guaranteed sale” purchase orders. Note that clients often misunderstand the meaning of “guaranteed sale terms.” In a guaranteed sale, the client guarantees that the customer will be able to sell all the products. The end-customer has the right to return any unsold product at any time.
f) The purchase order cannot be used for your first transaction for this product
This solution cannot be used to finance your company’s first purchase order. Your company must have sold the product (or similar) a couple of times before transactions can be financed. This requirement helps show the purchase order finance company that your company is comfortable with the manufacturing and delivery processes.
Learn more about the qualification requirements for PO financing.
Need purchase order financing?
We are a leading purchase order finance company and can provide competitive terms. If you would like more information, get an online quote or call us at (877) 300 3258.