How Loans Against Purchase Orders Work

One of the main challenges for a company is getting a large purchase order but not having enough money to fulfill it. This scenario can be a problem for product re-sellers, wholesalers, and distributors that are growing too quickly.

Business owners usually see this situation as a “good problem” to have. However, large orders are only a “good” problem if you find a way to fulfill them. Otherwise, you could end up with an unhappy customer.

One way to solve this problem is to look for a loan against your purchase order. However, getting a purchase order loan can be difficult since banks often have stringent qualification criteria. Unfortunately, few small business owners actually qualify for loans.

The solution

One alternative is to use purchase order (PO) financing. PO financing is a solution that allows you to finance your orders using your purchase orders as collateral. This strategy provides the funds to pay suppliers and allows you to fulfill your orders.

However, PO financing is not a loan. It uses a different structure. As a result, PO financing can be used by companies that would not qualify for conventional financing.

Who qualifies?

PO financing has simple qualification requirements and is easier to get than a conventional business loan. This solution can be used only by companies that re-sell finished products to commercial clients. In other words, clients must buy goods from a supplier and resell them to their customers for a markup. Aside from that, the client must have a reasonable profit margin.

Companies that use a third-party manufacturing partner can often qualify for this type of funding as well. If your company is a direct manufacturer of goods, consider supplier financing instead.

How does the transaction work?

The transaction is relatively simple. Once you have an order, you partner with a finance company who pays your supplier. After the payment is made, your supplier manufactures and delivers the goods. This transaction allows you to fulfill the order and invoice your client.

The transaction settles once your client pays in full. You can learn more about how a transaction works by reading this article.

How much does it cost?

In general, purchase order financing rates average about 3% per 30 days. The rate is often prorated after 30 days. However, the actual rate can be higher or lower based on the transaction. Consequently, PO financing should be used only by companies whose gross margins exceed 20%.

The rate is often determined by:

  • Your experience in the industry
  • The size of the transaction
  • The reputation of your supplier
  • The creditworthiness of your client
  • The transaction structure
  • Other risks

Benefits

Purchase order financing has a number of benefits and advantages, especially for small companies, including:

  • It’s available to start-ups and companies with limited history
  • It’s easier to get than bank financing
  • It can be set up quickly
  • The line is flexible and can grow

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