Managing the cash flow of an import company can be challenging for a small or mid-sized company. While import companies can be profitable and have high gross margins, they require a substantial cash reserve to operate. And you need an even bigger cash reserve if your company is growing or taking larger orders.
You need this reserve because of the 30- to 160-day delay between the time you pay your suppliers and the time that you are paid by your clients.
The supplier payment challenge
Most foreign suppliers demand a prepayment, or payment by letter of credit, if you buy goods from them. This demand is common for foreign purchases, especially if you import goods from China or other Asian countries, for two simple reasons:
- They may not trust you, so they want you to pay in advance.
- They may need the money themselves to handle production for your order.
The problem is that prepaying can be costly and risky. If you prepay by bank wire, you open yourself to the possibility that your supplier will not deliver. If your supplier does not deliver, you lose your payment. The better option is to prepay with a well-written letter of credit. The problem with letters of credit, however, is that your bank will issue one only if you post collateral, either in cash or through credit. Those funds (or credit) will be tied up until your transaction ends.
The trade credit problem
On the other hand, if you work with large retailers or commercial clients, they usually demand trade credit. Consequently, you must offer them anywhere from 30 to 60 days to pay invoices. You often have little choice in the matter.
Large companies demand payment terms as a condition of doing business. If you don’t offer credit, they’ll find one of your competitors who will.
The cash flow problem
Once you include your order’s manufacturing time and transport time, it may take up to 160 days from the time you paid your suppliers until your client pays you. This delay can create a problem for companies that don’t have substantial reserves, or those that are growing quickly.
You may simply run out of money and be unable to fulfill more purchase orders until your clients start paying. This problem is serious.
Bridging the gap
One way to bridge this cash flow gap is to use purchase order (PO) financing. This solution provides funds to pay your suppliers, using your confirmed purchase order from a creditworthy client as collateral. PO financing enables you to handle your supplier payments without tying up your funds for a long time.
When used correctly, PO financing allows you to take orders that exceed your current capitalization and financial resources. This benefit enables you to grow your business to its potential.
Purchase order financing works by using your client’s purchase order as collateral for the transaction. As such, your client should have good commercial credit. PO financing can pay for the supplier costs associated with the specific order that you are financing. This payment enables the supplier to deliver the goods to the customer.
Payment to your supplier is done through a letter of credit. This method helps ensure that your vendor meets your product quality and quantity requirements. The goods must be inspected through a third-party inspection company, such as SGS inspections, to ensure compliance.
Once the goods are delivered to your client, you can send an invoice to your client. At this point, it’s common to use invoice factoring and use the proceeds to close the PO financing line. Since invoice factoring is less expensive than PO financing, this approach often lowers the total transaction cost.
Benefits of purchase order financing
PO financing has many benefits. First, because the line transaction-oriented, the line can grow with your business. The size of the line is determined by the credit quality of your order, the capabilities of your supplier, and your ability to execute the order. Second, qualifying for this type of financing is easier – and faster – than getting conventional business financing. This accessibility makes PO financing an ideal option for companies that are growing quickly and need immediate funds to capitalize on new opportunities.
However, purchase order financing has some limitations. It works only for transactions that:
- Resell finished goods
- Have gross margins greater than 20%
- Have a creditworthy client
- Are not for consignment or guaranteed sales
Get more information
We are a leading purchase order financing company in Canada and can provide you with competitive terms. For a quote, fill out this form or call us toll-free at (877) 300 3258.