Purchase order financing helps small companies with the supplier costs associated with a large order. It enables small business owners to fulfill large orders and book the revenue. This article discusses how purchase order finance companies pay your supplier expenses. We cover:
- Why is your supplier asking for a prepayment?
- Reliable supplier payment methods
- High-risk supplier payment methods
For more information, read “What is Purchase Order Financing? How Does it Work?”
1. Why is your supplier asking for a prepayment?
A supplier may ask you to prepay for goods, or at least put a down payment, for either of the following two reasons:
Reason #1: Your supplier is uncomfortable offering credit to you
This problem is common if the supplier doesn’t know your company well. While they can easily fulfill the order, they are not comfortable with your company’s credit profile. The supplier could be reluctant to offer credit because your company is new or your order is especially large. The supplier asks for a prepayment because they want assurance that they will get paid when they complete the order.
Purchase order financing is often a great solution in this scenario. Your company can leverage the PO finance company’s credit strength and use an appropriate payment method to address the supplier’s concerns.
Reason #2: Your supplier needs the prepayment to pay their suppliers
This situation is common if your supplier is small, has financial problems, needs financing, or is trying to fulfill an order too big for them. They ask you to prepay for goods because they need the funds to pay their own suppliers and employees. Basically, they are asking you to finance them.
PO funding won’t work in this scenario. Think about it this way: would you feel comfortable giving your supplier money if you had no assurance they would deliver? Remember, our business goal is to finance our clients – not to finance their suppliers.
2. Reliable supplier payment methods
We can pay suppliers in several ways. The following methods usually work well if your supplier can fulfill your order but is concerned about getting paid:
Method #1: Wire transfer at the time of shipment
If your supplier is large enough and has a good credit profile, we can pay them via wire transfer at the time of shipment. This method usually works well for transactions in which the supplier is based in the US or Canada. It usually won’t work if your supplier is overseas, as they are unlikely to ship and provide documents (needed to clear customs) without getting paid first.
Method #2: Cash against documents
This method works well for transactions in which suppliers are based locally or abroad. It offers protections similar to that of a letter of credit without having the detailed requirements needed to release payment. The transaction is usually intermediated through a bank that manages documents and releases payments.
Method #3: Letter of credit
This method is the safest way to pay a supplier. The finance company opens a letter of credit to the benefit of your supplier through an internationally recognized bank. This instrument guarantees your supplier their payment as long as they deliver your order in the correct quantity, specifications, and time frame.
Your supplier has the option to confirm the letter through their own bank, which can provide further guarantees of payment.
3. High-risk supplier payment methods
One of the greatest risks that finance companies face is paying a supplier that does not deliver the goods. This situation leaves your company and the finance company exposed to serious financial risk. For this reason, finance companies pay only when they are certain the goods will be delivered. Consequently, finance companies never use supplier payment methods that expose them to the possibility of paying but not getting the product.
a. Cash or wire transfer before or during manufacturing
We are unable to prepay a supplier via wire transfer or cash. There are two reasons for this position. As previously explained, requests for prepayment may indicate that the supplier needs the funds to buy the raw materials to fulfill your order. This request usually indicates that the supplier does not have the financial strength to easily deliver your order. It is a common red flag in purchase order financing transactions.
Additionally, the chance remains that the supplier takes the money but does not fulfill the order correctly. For example, the product could fail the quality tests. This scenario would create a serious and expensive problem.
Note: Exceptions can be made to this rule only if the supplier is a very large company, such as a member of the Fortune 1000 list.
b. “Proof of Funds” or “Ready, Willing, and Able” letters
We cannot provide “Proof of Funds” or so-called “Ready, Willing, and Able” letters. Some foreign suppliers ask for them. This message is sent via a SWIFT MT799 and contains a letter confirming that the buyer has the necessary funds for the transaction.
On the surface, these requests may appear reasonable. However, these instruments are open to abuse and are often used by dishonest actors. There are several ways these instruments can be abused and used to defraud buyers. Here is one example of misuse, according to the FBI. In our experience, these instruments are not necessary when working with well-established and legitimate sellers
International transactions are commonly done with letters of credit. These instruments are specifically written to protect the interests of the buyer and the seller. Seller payment is guaranteed by a financial institution as long as they meet the letter of credit terms.
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