Purchase order (PO) financing has been gaining popularity as a tool to fund large purchase orders. However, many prospective clients often misunderstand what is needed to qualify for this solution. Clients often believe that they only need a substantial purchase order to qualify. Unfortunately, this assumption is wrong.
Transactions often have a lot of moving parts. All of the parts need to work correctly for a transaction to be successful. Consequently, finance companies usually look into all the components during their due diligence process. This article covers the eight main requirements to determine if your transaction qualifies.
Quick summary: What is PO financing?
Purchase order financing helps companies that need funds to fulfill a large order. It provides resellers and distributors with financing to pay their suppliers. This funding enables them to fulfill larger orders and grow the business. Learn more about how it works and how much it costs.
1. Do you re-sell products?
This solution can be used only by companies that re-sell and distribute products. It cannot be used by companies that manufacture products directly or provide any services. Manufacturing companies should consider supplier financing instead.
2. Does the transaction qualify?
To qualify for financing, transactions must meet the following criteria:
- Be for a product re-sale
- Have a minimum value of $100,000
- Have a gross profit margin of at least 20% (although 30% is preferable)
- Be non-cancelable
- Not be for a guaranteed/consignment sale
- Not be your first transaction for this product
While start-ups commonly use PO financing, it cannot be used to finance your first sale or a brand new product. Finance companies need to see that the company has sold the product a few times. This track record shows that potential supply chain and transportation issues have been worked out.
3. Do your customers qualify?
The most important collateral for the transaction is your customer’s ability to pay for the order promptly. Purchase order finance companies evaluate your client’s creditworthiness to determine if they qualify. The credit reports must show that your client has paid invoices of a similar amount to your order on time. Note that if your customer is not creditworthy, the finance company won’t do the transaction.
4. Does your supplier qualify?
Most of the transaction’s risk is concentrated on your supplier’s ability to deliver your orders. Clients should review their suppliers carefully and ensure they can deliver before engaging with them. If your supplier has financial problems or requires a prepayment to fund their production, the supplier is not likely to qualify.
During due diligence, the funding company reviews your suppliers carefully. They verify that the supplier has the reputation and capabilities to deliver the product you’re asking for.
5. Does your supplier accept letters of credit?
Finance companies can prepay some US-based and Canadian suppliers as long as they are large, recognized companies (e.g., Fortune 500). Otherwise, finance companies pay your suppliers using a letter of credit.
Letters of credit are well-known payment tools that guarantee payment to your supplier as long as they deliver the goods. If your supplier is not willing to take a letter of credit, the finance company can wire funds. However, they can wire funds only after the goods have been inspected and shipped.
A finance company will never prepay a foreign supplier or a supplier with financial problems. The risk of these transactions is too high. There is little recourse to recover funds if the supplier fails to deliver the order.
6. Are you using a single supplier?
Transactions with a single supplier are the simplest to finance and have the highest chance of getting approved. Transactions that have multiple suppliers can be funded only if:
- Each supplier delivers a single complete product
- Your company is not assembling a product from various suppliers
- Your client accepts partial deliveries
Finance companies are cautious about working with multiple suppliers due to the risk. If you need all suppliers to deliver, but one fails, you could have a situation where you have to pay some of the suppliers but cannot fulfill the order. This situation would lead to a loss.
7. Does your company qualify?
As part of their due diligence, financing companies also evaluate your company. They review the following:
- Your company’s ability to execute the order
- Financial statements (P&L and balance Sheet)
- Purchase order
- Supplier and client contracts
- Public record information
- Other information (varies by company)
8. Do the company owners qualify?
Finance companies also examine the experience, background, and reputation of the company’s owners. After all, the owners are the ones executing the order. At a minimum, the owners should have industry experience. Ideally, they should have done similar transactions before looking for financing. Lastly, owners should be free of legal and other problems that could encumber the company.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.