Supply chain financing is a set of tools that companies use to improve their cash flow and their ability to run the business. It offers tools such as reverse factoring, supplier financing, and purchase order financing.
Factoring and reverse factoring are post-delivery financing tools. As such, they can help only after you have delivered your products and have invoiced your client.
1. What is purchase order financing and how does it work?
As its name implies, purchase order (PO) financing allows you to finance new purchase orders. It can be used by product distributors and resellers, and it can be used only to fulfill a purchase order. This product cannot be used:
- By companies that directly manufacture products
- To build inventory
Once you have a purchase order from a client, you submit it to the PO financing company for review. The company reviews the transaction and, if the transaction is approved, they pay the direct supplier cost.
The payment enables your supplier to manufacture the product and deliver it to you. The transaction concludes once your client pays for the goods, at which time you settle with the financing company. For more information, here is how PO financing works and how to qualify for it.
2. What is supplier financing and how does it work?
Much like purchase order financing, supplier financing is a pre-delivery financing solution. However, this solution offers some advantages over conventional PO financing. This solution can be used by:
- Direct manufacturers looking to buy raw materials
- Companies looking to build inventory
Supplier financing works by having the supplier financing company acts as a product intermediary between your supplier and your company. When you need to buy products or raw materials, you place an order with the supplier financing company. The company agrees to sell you the goods on credit and places a corresponding order with your supplier. The supplier completes the order and delivers the goods to you.
The supplier financing company issues an invoice to your company, payable on terms. The transaction settles once the invoice matures and you pay it. For more information, here is how supply chain financing works and who qualifies for the service.
3. Which one is better?
We think that, for most companies, supplier financing is the better alternative. However, there are exceptions to this recommendation.
Supplier financing can be better than PO financing because it works with both product distributors and manufacturers. Furthermore, it can be used to complement existing financing (e.g., a line of credit) because it does not encumber assets nor does it require you to file a lien.
However, there is a limitation. The supplier financing company can buy products on your behalf only up to the amount that your company can be credit insured. This limitation is significant, and it leaves open an important question: what happens if you get a very large order?
The size of a purchase order financing line, on the other hand, is limited only by the commercial credit rating of your client and the capabilities of your supplier. This increased financing capability is an advantage, especially if you sell to large companies.
However, PO financing has its own limitations. As mentioned before, it cannot be used by manufacturing companies. Also, the transaction is secured by your accounts receivable. As a secured transaction, PO financing does not work if you already have a lender in place (unless they subordinate their position).
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