Summary: Growing product distributors and wholesalers often have to manage difficult cash flows. They must balance their order flow and supplier expenses while working with clients who pay invoices in 30 days. This situation can lead to cash flow problems.
This article discusses how distributors can improve cash flow and finance growing orders. We review invoice factoring and purchase order financing, two solutions that can help finance your company. The article covers the following:
- Supplier invoices vs. client invoices
- Factoring vs. purchase order financing
- What is invoice factoring?
- Advantages of invoice factoring
- What is purchase order financing?
- Advantages of PO financing
- Limitations of purchase order funding
1. Supplier invoices vs. client Invoices
The largest expense for most distribution and wholesale companies is their supplier expense. It also has the greatest impact on cash flow since you may have to pay suppliers well before selling the product to your clients.
Supplier payments are not the only challenge. Slow client payments can also be a source of financial problems. This section covers both problems in more detail.
a) Supplier invoices and cash flow
Most established distributors can set up their suppliers as net-30 accounts. Consequently, the distribution company has 30 or more days to pay the supplier’s invoice. Getting payment terms from suppliers is an advantage because the distribution company can sell the products before they pay their supplier.
Small and growing distributors and wholesalers don’t always get the option to pay invoices in 30 days. Instead, they have to prepay for orders or pay on shipment. This situation affects their ability to grow and is often a source of financial problems.
b) Client invoices and cash flow
Distributors and wholesalers usually have to give net-30 terms (or longer) to their commercial and government clients. Offering payment terms gives the client 30 days to pay your invoices.
Larger distributors often have a cash reserve they can use to handle company expenses while waiting for client payments. However, most small companies don’t have an adequate cash reserve. This is a common source of problems as the company may be unable to meet its obligations until clients pay. This situation can escalate into a serious cash flow problem if not handled correctly.
c) Quick supplier payments and slow client payments
Most small distribution companies face the dual problem of paying suppliers quickly but waiting 30 to 60 days to get paid by clients. This situation exposes companies to cash flow problems, especially if they are startups or have just been awarded a large order.
2. Factoring vs. purchase order financing
Which solution you use and how it is deployed depends on the business challenge you are trying to solve. In general, you must consider two things:
a) You have enough A/R to cover expenses
Consider using invoice factoring if the amount in your accounts receivable is sufficient to cover your supplier expenses. Factoring is easier to get, more flexible, and more cost-effective than purchase order financing.
b) Your supplier costs exceed current A/R
Consider purchase order financing if you have a large order and your supplier payment exceeds your accounts receivable. This option can help cover your supplier costs for very large orders.
3. What is invoice factoring?
An invoice factoring line enables distributors to finance their accounts receivable. This solution is typically used by distributors who want to improve their cash flow because their clients pay on net-30 terms.
Small distributors often can’t wait 30 to 60 days for payment. Their cash reserves are limited, and they can’t cover all their expenses. A factoring line enables them to leverage their receivables and improve their cash flow.
Factoring lines work well with small and growing companies. These lines have simpler qualification requirements than other solutions. Additionally, lines can be deployed quickly.
a) How does factoring work?
Most factoring companies finance your invoices in two installments. The first installment covers about 85% of your invoice. The funds are usually deposited shortly after processing the invoice.
The remaining 15%, less the factoring fees, is deposited once your customer pays the invoice. Your customer can pay their invoice on their usual terms and do not need to pay faster.
The second installment settles the transaction. Distributors and wholesalers typically use factoring regularly. Factoring provides them with reliable cash flow.
Read “How Does Invoice Factoring Work?” to learn more.
4. Advantages of invoice factoring
Factoring has several advantages over conventional financing solutions. These are the most important advantages.
a) Improves cash flow quickly
Most factoring solutions can be deployed in a few days and improve your cash flow quickly. Factoring is typically used by companies that have an immediate cash flow need.
b) Simple qualification requirements
The qualification requirements for factoring are simpler than the requirements for products of comparable size. It is intended for small and growing businesses.
c) Adapts to your revenues
Factoring lines have a flexible limit determined by the quality of your invoices. The line can adapt to growing revenues as your company takes on new clients.
d) Enables you to offer payment terms
A factoring line allows you to offer net-30 payment terms to clients while minimizing cash flow concerns. It’s often used by companies that must offer terms to remain competitive but don’t have the required financial reserves to do so.
Read “Factoring Pros and Cons” to learn more.
5. What is purchase order financing?
Companies use purchase order financing to handle large orders from commercial or government clients. In most cases, the size of the orders exceeds the distributor’s financial capabilities. The distributor requires financing to fulfill the order.
PO financing enables distributors to handle the supplier payments associated with large orders. It provides financing so your vendor can deliver the goods and your company can fulfill the order.
This solution is typically used by small and growing companies that can’t qualify for conventional financing. It has simpler qualification criteria and can be set up in a week or two.
a) How does PO funding work?
The process begins when the finance company evaluates the transaction to ensure it qualifies for purchase order financing. Transactions that qualify proceed to the financing stage.
The PO financing company handles your supplier payment directly. All overseas suppliers (e.g., in Asia, etc.) must be paid with a letter of credit. A letter of credit can ensure the supplier’s payment as long as they comply with the order’s requirements.
Suppliers in the US or Canada may be prepaid by wire transfer if they are a large established company (e.g., Fortune 500). Otherwise, they are typically paid with a letter of credit.
Transactions can settle through a factoring line if you have one. This method can improve your cash flow in some cases. Alternatively, the transaction can settle with the PO financing company once your customer pays their invoice.
6. Advantages of PO financing
Purchase order funding has several advantages over comparable products. These advantages include the following:
a) Simple qualification criteria
Qualifying for purchase order financing is simpler and faster than qualifying for a line of credit. For detailed information, read “Purchase Order Financing Qualification Requirements.“
b) Available to small companies
The line is intended for small and mid-sized companies. Our typical client owns a well-operated company that can’t meet a conventional lender’s collateral and track record requirements.
c) Grows with your orders
One of the most important advantages of purchase order funding is that the line has no fixed limit, per se. Instead, the finance company establishes a limit based on the credit quality of your customer, your supplier’s track record, and your company’s capabilities.
7. Limitations of purchase order funding
Purchase order financing has some limitations that business owners must consider. The three most important limitations are as follows:
a) Available only for specific orders
This solution can finance only a narrow set of orders. The order must be a strict product re-sale to a creditworthy client. Furthermore, your profit margins must be above 20%.
b) Not available to manufacturing companies
Purchase order funding can’t be used by manufacturing companies or distributors that assemble complex products. These companies should consider supplier financing instead.
c) Expensive
Purchase order funding is comparatively expensive. It works best for transactions with high margins and timeframes under 90 days. Consequently, it must be used only on select transactions.
Get more information
Do you own a distribution company and need financing? We can provide factoring and PO financing at competitive rates. For more information, get an online quote or call us toll-free at (877) 300 3258.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.