What is Purchase Order Financing?

Summary: Purchase order financing helps small companies that have won a large order and need funds to pay their suppliers. The solution helps cover the vendor expenses, enabling you to fulfill the order and book the revenue.

PO funding has grown in popularity with Canadian resellers and distributors as a tool to grow their companies. This article explains how PO financing works, who it helps, and how transactions are settled.

  1. What is PO financing?
  2. Does your purchase order qualify?
  3. How does purchase order financing work?
  4. PO Financing advantages
  5. Provincial differences

Note: If you are in the USA, please go here.

1. What is purchase order financing?

Winning a large purchase order can provide a significant growth opportunity for a small business. However, the same order can become a major challenge if you don’t have the financial resources to fulfill it.

Most small companies face a simple problem. Their suppliers expect to be paid when the order is placed. However, the clients will pay 30 to 60 days after receiving the goods. This situation creates a financial gap that the small business must handle.

A purchase order financing program helps close this financial gap. It provides funds to pay your supplier. This enables you to fulfill the order and book the revenue. When used strategically, PO funding can help your business grow.

2. Does your order qualify?

Purchase order financing works only on specific transactions. The purchase order must meet the following criteria.

a) Product sales only

Purchase order financing can be used to finance product sales only. This solution is specifically designed to work with companies that resell products at a markup. It cannot be used to finance orders that provide services or assembly

b) Single supplier

The transaction works best if a single supplier delivers a completed product for the whole order. Orders that use multiple suppliers may be financed if the purchase order allows partial deliveries.

c) Approved supplier payment methods

Most suppliers want to be paid via a wire transfer before the goods are delivered. This arrangement may work if your supplier is a large public company (e.g., Fortune 1000) based in Canada or the USA.

Suppliers that aren’t large public companies and need a prepayment are paid with a Letter of Credit (LOC). A LOC protects both sides of the transaction, guaranteeing payment only if the supplier delivers.

All overseas suppliers must be paid using a LOC. This is a well-known and accepted payment method for import transactions.

d) Margins over 30%

Purchase order financing is comparatively expensive. It works only with transactions with a high gross margin, ideally over 30%. The solution can work with transactions with gross margins as low as 20%. However, the client will need to contribute funds, and the transaction should have a short turnaround timeframe.

e) Minimum order size

Each individual order must be for a minimum of $100,000. Unfortunately, most PO financing companies are unable to finance smaller orders.

f) Large commercial clients

The client who awarded the purchase order to your business must have good business credit. Their business credit backs the whole transaction.

3. How does it work?

The transaction format is simple and has four basic steps. Note that this assumes you have already set up an account with the finance company.

To learn more, read “How does purchase order financing work? (sample transaction)

Step #1 Supplier Payment

The first step in the transaction is to pay your supplier. In most cases, the supplier is paid with a LOC. Once the supplier receives the payment, they manufacture the product and prepare it for shipping.

Step #2: Product inspection

The product is typically inspected before shipment using a 3rd part inspection company, such as SGS. The inspection guarantees the product meets the quality and quality that are outlined in your order.

Step #3: Delivery and invoicing

Once the product passes inspection, the order is delivered to your client’s facility. Your company can send an invoice and then wait for payment. The next step is to wait until settlement.

Step #4: Transaction settlement

Transactions settle once your client pays their invoice. You can settle a transaction through the purchase order financing company or by factoring the invoice.

a) Keep the PO financing company

The simplest way to settle a transaction is to wait until your client pays the finance company. Once payment is received, the finance company subtracts the funds paid to your suppliers and their fees. The balance is remitted to your company.

b) Use factoring

You may also settle the transaction using invoice factoring. In some cases, this option is cheaper because the cost per dollar of factoring is usually lower than the cost per dollar for PO funding. Additionally, you may get some additional working capital if your margins are high enough.

Factoring is not always the best way to settle a transaction. Consequently, this must be evaluated on a case-by-case basis.

Read “What is factoring?” to learn more.

4. Advantages

Purchase order has several advantages over other solutions. The following are the most popular.

a) Deliver large orders

The main advantage of a purchase order financing program is that it enables your company to handle large orders. The solution enables you to grow your business beyond your current capitalization.

b) Grows with your business

The line does not have a pre-defined maximum limit. It can grow with your business as long as you have quality clients, reliable suppliers, and the expertise to fulfill the orders.

c) Simple qualification requirements

Purchase order financing has simpler qualification criteria than most comparable options. Your company must have:

  • A qualifying order
  • Sold the product before
  • No liens/encumbrances
  • Up-to-date financial statements

5. Provincial differences

Purchase order financing is available in all Canadian provinces. However, only a few spacialised companies are able to offer the service in Quebec. This is due to the differences in the legal system in Quebec, which determines how transactions are underwritten in the province.

Evaluate potential finance partners to ensure a track record of financing transactions for companies in the province. Otherwise, your transaction could face delays and other challenges.

Get more information

We are a leading purchase order financing company in Canada and can provide you with competitive terms. For more information, get an online quote or call (877) 300 3258.