What it is and how it can help you – Forbes Advisor

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Purchase order financing is a way to get the cash you need to pay for inventory and supplies before you receive payments from customers. When you have a purchase order from a customer, a lender provides the money to pay for the inventory. For this reason, purchase order financing can help keep your business running smoothly, even when times are tough.

What is purchase order financing?

Purchase order financing is short-term financing that can help businesses pay for the goods or services needed to fulfill customer orders. Finance companies pay vendors directly, so PO financing can help you avoid missing sales opportunities that you wouldn’t otherwise have the money to accept.

How does purchase order financing work?

Purchase order financing is a way for businesses to get the cash they need to pay for inventory and supplies before receiving payment from their customers. The finance company pays for the inventory directly and the supplier ships the product to the customer. Then, the finance company collects the payment on the customer’s unpaid bill. Finally, the corporate borrower receives cash from the finance company, net of interest and fees.

Here are the parties that are traditionally involved in purchase order financing:

  • Company (borrower). The borrower is the company that needs financing to pay for goods or services already ordered by its customers. The company borrows funds from a purchase order finance company to fulfill the order.
  • Purchase Order Finance Company. Also known as a lender, the purchase order finance company provides financing to the borrower. The lender confirms the details of the borrower’s purchase order and then sends the funds directly to the relevant supplier.
  • Supplier. The supplier provides the goods or services ordered by the customer. In some cases, the supplier may also be involved in financing the purchase order.
  • Customer. The customer is the party that buys the goods or services from the borrowing company. Under a purchase order financing arrangement, the supplier sends goods to the customer and the customer’s payment goes directly to the lender.

How to finance a purchase order

If you want to apply for purchase order financing, contact a lender directly or work with a finance company that specializes in this type of financing.

You’ll need to provide information about your business, the order you want to finance, the customers involved, and your financial history. The lender then decides whether or not to approve your loan and make you an offer.

Unlike many other types of business financing, the approval process may depend more on the creditworthiness of your customers, not your business. This is because customers have an impact on whether the finance company receives payment on time.

Typically, monthly PO financing rates range from 1% to 6% of supplier costs, with rates increasing the longer the customer takes to pay their invoice. These interest rates translate to annual percentage rates (APR) of between 20% and 50%, making purchase order financing an expensive option.

Here are the general steps involved in financing a purchase order:

  1. The company receives a purchase order from the customer
  2. The company determines how much it will cost to fulfill the order
  3. Company requests purchase order financing
  4. Purchase order finance company pays the affected vendor
  5. The supplier ships the product directly to the customer
  6. The company invoices the customer
  7. The customer pays the bill to the finance company
  8. The finance company sends the funds to the business, less interest and fees

Where to Get Purchase Order Financing

Purchase order financing is available from online finance companies, some of which exclusively offer these business loans. For example, providers like PurchaseOrderFinancing.com specialize in this type of loan while companies like SMB Compass offer a range of financing options. Some banks and traditional lenders also offer purchase order financing to eligible businesses.

How to Choose a Purchase Order Finance Company

If you’re considering using purchase order financing for your business, compare lenders before committing to terms. Consider these factors when choosing a purchase order finance company that best suits your needs:

  • Services available. Choose a company that specializes in purchase order financing rather than one that offers it as a complement to factoring services or other financing tools. For example, some lenders specialize in small personal loans or traditional business loans, but may not have the expertise to work directly with vendors.
  • Experience in your industry. Consider a supplier who is experienced in your industry and familiar with your products and services. Also, assess how long the finance company has been in business and working with companies in your industry.
  • Borrower Requirements. Depending on the provider, you or your business may need to meet a minimum credit score requirement. However, lending decisions may be based more on customer payment history. It may also be necessary to constitute a personal guarantee in the event of non-payment of the invoice by the customer.
  • Minimum annual volume requirements. Some vendors have minimum annual revenue or order volume requirements. Select a finance company that matches your needs.
  • Overall cost of financing. Compare monthly financing fees and assess additional fees charged by each provider, including processing or start-up fees. Likewise, find out if rates increase as your customers take time to pay their bills.
  • Vendor Payment Methods. Purchase order finance companies pay vendors in a number of ways, including cash and wire transfer. Payment with a letter of credit is considered the safest method of payment, although not all suppliers accept this method. Choose a finance company that offers flexible payment methods.

Advantages and Disadvantages of Purchase Order Financing

Before applying for purchase order financing, carefully weigh the pros and cons to determine if this financing is right for your business.

Advantages

Purchase order financing can be a useful way to fund orders when you don’t have the cash to pay for them up front. It can also help you grow your business by allowing you to take larger orders. Some of the other benefits of this type of loan include:

  • Access to working capital. Purchase order financing can provide the working capital needed to fulfill customer orders. It can help you maintain or grow your business by taking orders from customers you may not have had the funds for.
  • Easier to qualify. Finance companies typically base their approval decisions on a customer’s creditworthiness. The lender will always consider your company’s finances and credit profile, but this can make it easier for startups to qualify for funding.
  • Improved relationships with suppliers. Purchase order financing can help improve your relationships with suppliers by allowing you to pay for goods on time. This can lead to early payment discounts and better terms in the future.

The inconvenients

Purchase order financing also has some potential drawbacks, including:

  • High costs. This form of financing can be expensive, with pay-to-order financing rates ranging from 1% to 6% of supplier costs. These numbers translate to APRs of around 20% to 50%.
  • Assigned by customers. Your client’s purchase order secures your loan, so many lenders approve the borrowing company based on their clients’ creditworthiness. Also, the longer it takes a customer to pay their bill, the more you risk incurring charges.
  • Reduced control of operations. Since purchase order financing companies pay vendors directly, this method of financing takes some power away from the business owner. The supplier also ships products directly to the customer, further separating the business from operations and customer relationships.

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