How to Choose the Best Purchase Order Financing Company

The market is full of companies that advertise purchase order (PO) financing programs. However, only a few companies have the experience, knowledge, and capital to handle these transactions successfully. Choosing the right finance company is important because it plays a critical role in the outcome of your transaction. In this article, we discuss:

  1. What do to before you start your search?
  2. How to interview a finance company
  3. Determine which company is right for you

1. What to do before starting?

The best way to have a productive discussion with a finance company is to come well-prepared to the meeting. On the surface, most PO financing transactions appear simple. The reality is different, though. Transactions often have many contractual contingencies tied to them: manufacturing schedules, quality requirements, PO conditions, etc. All of these components play important roles. A finance company will not be able to provide you with a meaningful proposal unless you have this information ready:

  • Client information
  • Supplier information and costs
  • Logistics details
  • Production and delivery timetables
  • Recent A/R aging report
  • Recent P&L statement
  • Copy of your purchase order
  • Expected gross profit margins

Additionally, it helps to approach the conversation with a good understanding of how PO financing works, its advantages and disadvantages, qualification requirements, and costs. This knowledge gives you a basic idea of whether this solution is right for you.

2. What questions should you ask?

The following list of questions addresses the subjects you should cover as you interview finance companies. The finance company’s answers to these questions should provide the information you need to determine which company is the best fit for your transaction.

a) Do they focus on PO financing, or do they offer it “on the side”?

Many factoring companies advertise that they provide purchase order financing “as well.” They actually offer PO financing to accommodate a few clients and win larger factoring deals. In most cases, these companies dedicate most of their resources to invoice factoring, while handling only a few PO financing transactions per year.

This approach can work in cases where the transaction is small, simple, or not strategic. Furthermore, these companies will work with you only if you plan to use PO financing in combination with factoring.

Most PO financing transactions are complex and require industry expertise. Without this expertise, there is a high risk that the transaction could unravel, compromising the entire portfolio. If your transaction is large, complex, or strategic, you are usually better off working with a company that has a full-fledged trade finance department.

b) Have they handled a transaction in your industry?

Choose a finance company with experience in your industry – or similar industries. Most large companies have complex master purchase agreements, and you are better off working with someone familiar with them. Also, if you work with large corporate clients (e.g., Walmart, Costco, etc.), partner with a company that has handled purchase orders from that client before.

c) Do they only use letters of credit to pay suppliers?

Paying suppliers with letters of credit is one of the safest transaction methods. As a result, many finance companies only handle transactions that involve suppliers who accept letters of credit as a form of payment. Keep in mind that some suppliers are not comfortable working with letters of credit, as they can be complex and cumbersome.

If possible, select a company that is also comfortable using cash against documents or paying by wire transfer after inspection/shipment. Note that payments to foreign suppliers are usually made with a letter of credit. Learn more about “How PO Financing Companies Pay Suppliers.”

d) How do they handle supplier prepayments?

Many foreign manufacturers/suppliers require a deposit payment before working for a specific order. Prepayments can create complications since they can increase the risk of the transaction. As such, some finance companies refuse to make prepayments. There are methods to handle prepayments effectively. However, they require that your supplier accepts working with a letter of credit. Ask your finance company how they handle prepayments to ensure you are comfortable with their payment methods.

Note: Keep in mind that PO finance companies will not prepay your supplier if the supplier needs the funds to buy raw materials to fulfill your order. In some cases, that request may indicate that the supplier has financial problems. Also, PO finance companies will never prepay a foreign supplier using a wire transfer.

e) How do they handle guaranteed sale clauses?

Many contracts from large corporate buyers have a guaranteed sale clause. This clause allows the client to return any unsold inventory and demand a full refund. Several companies that sell products on TV have these clauses. Unfortunately, guaranteed payment clauses can derail most transactions.

However, there are ways to negotiate better terms with your clients to reduce the risk of these clauses. If these clauses affect your order, choose a company with experience handling them.

f) Do they have minimums?

Some purchase order finance companies have minimum yearly volume requirements. The company requires that you finance a certain volume of transactions with them. Otherwise, you pay a penalty. In principle, there is nothing wrong with these policies. They ensure that only companies that will use the service sign up as clients. However, these policies can inadvertently affect small businesses that have low volumes. Understand these terms before signing on with any company.

g) How long have they been in business?

This question may seem obvious, but it’s actually quite important: ask your prospective finance company how long they have been in business. Select a company that has been in business for at least a few years, though longer is preferable. Purchase order funding is a growing field, and new companies are entering the industry every month. Consequently, many finance companies have limited experience and have not been market-tested. Working with these companies can be risky, especially if the owners are not seasoned industry veterans.

3. Which company is right for you?

The questions we covered in the previous section should provide you with a good idea of the capabilities of each finance company you interview. The final step is to select the best company to fit your needs. Here are some suggestions to help you with the selection process.

a) Are you comfortable with the company?

This is the most important suggestion we can give you. It’s best to avoid working with a company you are uncomfortable with, regardless of their terms or rates. You will be working with them for some time, so it’s important to feel comfortable with them and their offer.

b) Do their financial terms work for you?

Add the cost of financing to your existing transaction costs. Is the transaction still worth it once you consider those costs? Perhaps more importantly, is that transaction still profitable? PO financing is not cheap and is best used with high-margin transactions.

c) Are they comfortable working your transaction?

Sometimes finance companies take on transactions that they are not comfortable with. They may do this to meet some sales targets or other similar reasons. If you get the impression they are not comfortable with you, consider finding a different partner.

Need purchase order financing?

We are a leading PO financing company and can provide you with competitive terms. For more information, get a quote or call (877) 300 3258.

Note: If you are also looking for a factoring company, review “How to Select a Factoring Company“.