Who Can Use Purchase Order Financing?

Purchase order (PO) financing is a flexible product that can help small companies handle large sales. However, PO funding has some limitations and is not for every company. This article helps you understand PO financing and determine if your company is a good candidate for it. The following topics are discussed:

  1. What is PO financing?
  2. Advantages and disadvantages
  3. Is this the right solution for your company?

1. What is purchase order financing?

Getting a large purchase order can be a great opportunity for a small business. Companies can use large orders as a stepping stone to more profitable opportunities. However, getting a large order also has a financial downside. Many companies cannot afford to fulfill these orders because they lack the funds. Consequently, they miss an important opportunity to grow the business.

The main financial challenge that companies deal with stems from the timing of payments. Large companies usually pay their invoices in net-30 to net-60 days. This situation gives them a cash flow advantage since they can use your products for up to two months before they have to pay. Small companies don’t get that advantage. Suppliers insist that they prepay for their products prior to shipment. They must use their cash immediately. However, that is only one side of the problem.

Small companies still have to offer net-30 terms to their larger clients. Whenever they get a sizable order, they must pay the supplier immediately but wait a month or two to get paid by their client. This situation prevents small companies and startups from handling many (or any) larger orders and affects their ability to grow.

Purchase order financing can effectively solve this problem, allowing your company to handle larger orders and grow. The finance company pays your supplier directly. This payment allows you to fulfill the transaction while minimizing the effects on your finances. The transaction settles once your end customer pays the invoice in full. When used correctly, PO funding can help your company grow by enabling you to fulfill more sales. To learn more, read “What is Purchase Order Funding? How Does it Work?

2. Advantages

Purchase order financing can provide a competitive advantage to companies that qualify for it. The following are the most important advantages.

a) Enables you to fulfill large orders

When used strategically, PO funding can be used as a stepping stone to grow the company to the next stage. It can enable small companies to fulfill large orders that far exceed their current level of funding. When used strategically, it enables you to grow the business quickly. This benefit is the most important advantage of this product, and the main reason companies get it.

b) Can cover up to 100% of your supplier costs

The financing line can cover up to 100% of the supplier costs in transactions if the gross margins are above 30%. This benefit enables small companies to use their cash flow more efficiently and process more orders.

c) The line can grow quickly

The financing line is not constrained by conventional banking credit limits. Instead, the line can grow to match your needs as long as your clients have good credit, your suppliers can deliver, and your company can fulfill them.

d) Available to new companies

Unlike other solutions, companies with a short track record of sales can qualify for PO financing. It’s one of the few solutions that can help startups and can be an ideal option for new businesses.

3. Can PO financing help your company?

Purchase order financing can help your company if you sell products and have more orders than funds to fulfill them. While the following list is not a complete list of qualification requirements, companies that meet these criteria have a good chance of benefiting from using PO funding.

a) You must be a distributor (or re-seller)

Purchase order funding can only help companies that re-sell products, ideally from a single supplier. The order cannot include services such as consulting, assembly, or installation. This restriction significantly narrows the field of companies that can use purchase order funding. Manufacturing companies cannot use PO financing. However, PO funding can be used by distributors that rely on third-party manufacturing. Manufacturing companies should consider supplier financing, which is designed to help manufacturing companies.

b) You have an order above $50,000

Setting up a transaction is labor-intensive and expensive for the finance company. Consequently, finance companies only work with transactions that are above a minimum value. Most companies prefer transactions to be for a minimum of $50,000 per order. Minimums vary by company. Some companies have higher minimums, while others can work with smaller accounts.

c) You must have high gross margins

PO financing is expensive due to the inherent risk of financing purchase orders. The average rate is about 3% per 30 days, though this rate varies by transaction. In general, this solution works best for transactions that last less than 90 days and whose gross margins are higher than 30%. Transactions that have low margins or take too long run the risk of becoming unprofitable.

d) Your commercial clients must be financially solid

The main collateral for the transaction is your client’s ability to pay the invoice that is generated after you fulfill the order. Finance companies evaluate the commercial credit of your clients very carefully to minimize the risk of default. A finance company will only engage in transactions if your client has excellent commercial credit. The finance company looks at your client’s:

  • Track record of paying for large invoices
  • Length of time to pay an invoice
  • Risk of default

e) Your supplier must have a good track record

The supplier plays a key role in the success of the transaction. Finance companies evaluate your suppliers to determine if they have the technical and financial capabilities to fulfill your order. The finance company can guarantee payment. However, the order will be paid only after the goods are shipped. Due to the risk, finance companies do not prepay foreign suppliers by wire transfers. To learn more, read “How PO Finance Companies Pay Suppliers.

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