Factoring and Term Loans: A PO Financing Alternative

One of the greatest challenges for a small business is being able to fulfill large purchase orders. Small companies often lack the funds to pay suppliers and other expenses associated with large orders.

Most companies try to use financing – when it is available – to solve this problem. One common option is purchase order financing.

Although PO financing can work well, it works only for certain types of companies. Many transactions end up disqualified for various reasons. Unfortunately, this situation leaves many prospective clients out of the running.

In this article, we learn:

  1. What PO financing is
  2. Limitations of PO financing
  3. Why using term loans solves the problem
  4. What about cash flow?
  5. What is accounts receivable factoring?
  6. Problems combining term loans and factoring
  7. When to combine a term loan with factoring

1. What is PO financing?

Purchase order financing helps resellers cover supplier costs associated with a large order. Basically, a finance company pays your supplier expenses. This payment enables you to ship the goods to your client, which fulfills the order. Transactions settle once the client pays in full. Learn more about PO financing.

This solution can work very well for some companies. However, PO financing has some limitations.

2. What are the limitations of PO financing?

The following five major limitations disqualify the majority of opportunities:

a) It does not help manufacturing companies

Purchase order funding cannot help manufacturing companies because finance companies see the manufacturing process as one of the biggest risks to the transaction.

Finance companies are concerned about paying for production costs but being unable to fulfill the transaction due to manufacturing errors. This scenario leaves them stuck with the loss.

This situation is unfortunate. Manufacturing companies represent the largest proportion of companies seeking purchase order financing.

b) It works only if you resell goods that someone else manufactures

PO funding helps you only if you resell finished goods that are manufactured by someone else. This requirement protects lenders, who limit manufacturing risk by paying suppliers with a letter of credit.

Letters of credit are issued through banks. They guarantee the supplier payment, provided the supplier delivers the goods on time.

c) Your product must use a single manufacturing company

PO funding can only finance transactions that use a single manufacturing company. Multiple suppliers increase the risk to the transaction. Why? If one supplier fails to deliver, the whole order could fail, resulting in a loss.

This risk is another major roadblock, since few companies use a single supplier to make their products. They often need a few specialized suppliers for parts and materials.

d) You cannot not modify or customize the end product

Modifying the end product (after the supplier has delivered it) is not allowed. This action is considered similar to “manufacturing” by the finance company.

This requirement creates a limitation for clients. It prevents them from adding value to the product they resell.

e) Your contract must not include services

Lastly, your contract with your client cannot include any services. Again, this restriction is due to risk. Problems with the service component of a contract could affect the payment for delivered goods.

Learn more about PO financing’s qualification requirements.

3. Why are term loans a possible solution?

So, if purchase order funding is not an option – what solution can you use? One option is to use a term loan. Term loans are issued based on your cash flow and assets. They don’t depend on the details of a specific transaction. They are flexible and are much cheaper than PO financing (learn about the cost of PO funding).

Term loans can be very useful if you want to handle a short-term project, such as:

  • New client orders
  • Orders for new products
  • Large orders that exceed your available funds

More importantly, terms loans don’t have the restrictions of purchase order financing. You can use a loan to finance any aspect of your production process. This flexibility makes term loans a great alternative to purchase order financing.

4. What about your cash flow?

Term loans may provide the funds to handle large orders. However, this doesn’t mean you won’t have cash flow problems. Why? After delivering the project (or order), you still have to wait 30 to 60 days for your client’s payment.

Few small or growing companies can afford to wait through the long payment cycle – especially if they have other pending large orders.

One solution to this problem is to factor your accounts receivables. When combined with a term loan, factoring provides a great solution to finance purchase orders.

5. What is accounts receivable factoring?

Accounts receivable factoring allows you to finance slow-paying invoices from commercial clients. It improves your cash flow, providing funds to operate and grow the business.

Factoring has a number of advantages. It’s relatively easy to qualify for it. It’s quick to set up. And the line increases as your sales increase. Learn more account accounts receivable factoring.

6. Problems combining factoring and term loans

While combining terms loans and factoring has advantages, it isn’t always easy to do. Most factors and lenders want to have a first-position UCC lien against your invoices. This requirement makes sense, as they are secured transactions.

However, this requirement also creates a problem. And, unfortunately, many lenders refuse to work together.

However, some factors have teamed with lenders to offer this service. They have pre-arranged subordination agreements that support second-lien term loans. This agreement allows them to offer this financing package.

7. When does combining AR factoring and a term loan make sense?

Combining factoring and term loans makes sense if you are looking for an alternative to purchase order financing. Consider this solution if you cannot get PO financing and:

  1. You have a one-off large order/project
  2. You manufacture products
  3. You offer products and services

Looking for financing?

We are a leading provider of factoring, PO financing, and other solutions. The best way to reach us is to fill out the quote form. Or, you can call us at (877) 300 3258.