Purchase Order Financing

Purchase order financing can be a good option for cash-strapped companies that still want to be able to fill an influx of orders.

Purchase order financing, also known as purchase order financing, gives you the ability to pay your suppliers for the goods you need to fulfill outstanding customer orders. This type of financing can make sense for small businesses that receive more sales and orders than they have inventory or cash to fill, and don’t want to turn customers away.

Here’s what you need to know about purchase order financing, how it works, and where to get it for your business.

What is purchase order financing?

Purchase order financing is a cash advance that small business owners can receive on their purchase orders. With PO financing, a lender will pay your outside vendor up to 100% of the costs necessary to produce and deliver the agreed-upon goods to your customer.

Once your customer receives the goods, they invoice you for the order fulfilled and pay the PO financing company directly. Then, the PO financing company deducts their fees and pays you the remainder.

How does purchase order financing work?

With traditional small business loans, only two parties are involved: you and the lender providing the funds. However, when you enter into a purchase order financing agreement, you will typically work with the following parties throughout the process:

• Your company/the borrower: You, are seeking financing to fulfill a purchase order for your business.
• Purchase order financing company: The company offering the financing. This company verifies your purchase order and provides funds to the supplier.
• Supplier: The third party that supplies or manufactures the goods you resell or distribute. The supplier receives payment for your goods directly from the purchase order financing company.
• Customer: Your customer, the party who intends to purchase the goods. In a purchase order financing arrangement, after your customer has received your goods, he usually pays the financing company directly.

Here’s a breakdown of how purchase order financing works:

• You receive a purchase order. Your company receives a large order from a customer, but you don’t think you have the inventory or cash on hand to fulfill it.
• You determine the costs. You contact your supplier to determine how much it will cost to complete the order. Based on the cost assessment your supplier provides, you can confirm whether you will need to request financing to fulfill the order.
• You apply for purchase order financing. Once you have decided that you need purchase order financing, you will want to find the right purchase order financing company, submit an application and hopefully receive approval. You must submit the purchase order and the vendor’s estimated cost as part of your application. The finance company may approve you for up to 100% of the supplier’s costs, depending on the qualifications of your business, the supplier’s history and reputation, and the customer’s creditworthiness. It is important to note that if the financing company approves you for only a percentage of financing, say 90% of the supplier’s costs, you will be responsible for covering the remaining 10% on your own.
• The purchase order financing company pays the supplier. Once approved, the purchase order financing company will pay your supplier to manufacture and deliver the goods needed to fulfill the customer’s purchase order. Many financing companies will pay suppliers by letter of credit, an official bank guarantee that payment will be made once certain conditions are met, in this case, once the goods have been shipped and proof of shipment has been provided.
• The supplier delivers the goods to the customer. The supplier ships the goods directly to the customer. Once the customer receives the goods, the order is complete.
• You invoice the customer. Once the customer receives the goods, you send the customer an invoice for the order. You also send the invoice to the purchase order financing company.
• The customer pays the financing company purchase order. The customer pays the finance company directly for the total invoice price.
• The finance company deducts its fees and transfers its funds. After receiving payment from the customer, the purchase order financing company deducts its fees and pays you the remaining balance of the proceeds.

How much does purchase order financing cost?

Purchase order financing fees generally range from 1% to 6% per month and are usually priced per 30-day period. These fees are charged on the supplier’s total costs, but generally, increase the longer it takes your customer to pay their invoice.

Suppose, for example, you have a purchase order financing agreement where you pay the supplier $100,000. The finance company charges a 2% fee for 30 days. If your customer takes 30 days to pay your invoice, your total fees are 2% of $100,000 or $2,000. If your customer takes 60 days to pay your invoice, on the other hand, your total fees equal 4% of $100,000 or $4,000.

These rates may seem low; however, since they are not traditional commercial loan interest rates, it is important to calculate them in annual percentage rates to understand the true cost of financing. APRs on purchase order financing often drop more than 20%.

Some purchase order financing companies may also use a rate structure where you receive a fixed rate for the first 30 days and then a lower rate for a specified number of days until your customer pays.

For example, a company may charge 3% every 30 days and then 1% every 10 days, or 3% every 30 days and then 0.1% every day.

The purchase order financing rates you receive will ultimately depend on factors such as your company’s qualifications, the creditworthiness of your customer, and the reputation of your supplier.

Advantages and Disadvantages of Purchase Order Financing

Advantages

• Allows you to accept customer orders that you would not otherwise be able to fulfill. Purchase order financing can be a good option for seasonal businesses, or those that are growing rapidly and need additional capital to fill large customer orders. Similarly, this type of financing may be worthwhile for businesses that are experiencing a cash flow shortage and could benefit from an order that would generate significant revenue.
• It may be easier to qualify than other types of business financing. Many purchase order financing companies focus on the creditworthiness of their customers and the reputation of their suppliers first and foremost when evaluating your company’s request for financing. While these companies will still consider traditional business loan requirements, such as your company’s financials and credit history, it may be easier for startups and companies with bad credit to qualify compared to other types of business financing.
• It does not require budgeting monthly or weekly loan payments. Although you are borrowing money, purchase order financing is not technically a loan, so you don’t have to worry about repaying the funds in monthly or weekly installments, as you would with a commercial term loan.

Disadvantages

• Can be costly. Purchase order financing rates may seem competitive at first glance, typically ranging from 1% to 6% of the vendor’s total costs per month, but when you calculate these rates in an APR, the rates can be much higher. Anecdotally, they can range from 20% to over 50%.
• Reliance on customers. The amount you pay in fees is based on how long it takes your customer to pay their invoice, which means it is difficult to estimate the total cost of PO financing upfront. In addition, to access PO financing, you must rely on your customer’s creditworthiness (in addition to other factors) to qualify.
• Loss of control. With purchase order financing, the company you work with manages an important part of the process, including payment to your supplier and collection from your customer. Your supplier also ships products directly to your customer, which means you don’t have your hands in that part of the process either. While this can save your business time, it can also mean that processes are not handled the way you prefer, which could put your supplier or customer relationships at risk. Disadvantages
  Can be costly. Purchase order financing rates may seem competitive at first glance, typically ranging from 1% to 6% of total supplier costs per month, but when you calculate these rates in an APR, the rates can be much higher. Anecdotally, they can range from 20% to over 50%.
• Reliance on customers. The amount you pay in fees is based on how long it takes your customer to pay their invoice, which means it is difficult to estimate the total cost of PO financing upfront. In addition, to access PO financing, you must rely on your customer’s creditworthiness (in addition to other factors) to qualify.
• Loss of control. With PO financing, the company you work with manages a significant part of the process, including payment to your supplier and collection from your customer. Your supplier also ships products directly to your customer, which means you don’t have your hands in that part of the process either. While this can save your business time, it can also mean that processes are not handled the way you prefer, which could put your supplier or customer relationships at risk.

Where to get purchase order financing

Purchase order financing is usually offered by online financing companies, many of which specialize in this type of commercial financing. Some banks may offer purchase order financing for existing customers or larger-scale customers, but typically do not advertise or offer these services for small businesses.

If you’re looking for a place to start your search, here are some of the best purchase order financing companies to consider:

• SMB Compass. SMB Compass offers purchase order financing in amounts typically ranging from $25,000 to $10 million, with rates of 1.5% to 3.5% and a financing term of fewer than 30 days. The company also offers other types of commercial loans, including inventory financing, invoice financing, and equipment financing.
• Purchase Order Financing.com. As the name implies, this company focuses exclusively on PO financing, offering up to 100% financing of your supplier’s costs for amounts from $500,000 to $25 million. PurchaseOrderFinancing.com does not specify its online rates: the company only states that it gets “a small percentage of the profits it makes on the specific deal being financed.” Once you’ve started the application process, you can expect a response from PurchaseOrderFinancing.com within about 72 hours, and qualified companies can finance within seven to 14 days.
• King Trade Capital. According to its website, King Trade Capital is the largest purchase order financing company in the U.S. and provides financing to small and medium-sized businesses across the country. Unfortunately, King Trade does not provide many details about its services upfront, but interested companies can submit a financing application for more information through the website.
• Liquid Capital. Liquid Capital specializes in asset-based financing solutions such as purchase order financing, invoice factoring, and inventory financing. Liquid Capital’s purchase order financing covers up to 100% of vendor costs and offers up to $10 million in financing. Qualified companies can receive financing in as little as 24 hours. Although the company says there are no hidden terms with its financing, it does not provide rate or fee information on its website.