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Purchase Order Financing
What is Purchase Order Financing?
Purchase order (PO) financing is a short-term business financing option that provides you the money to pay suppliers upfront for legitimate orders. Businesses try to avoid using up their cash reserves or turning down orders due to cash flow issues.
PO financing enables businesses to quickly alter the loan basis upward or downward to suit their requirements and accept orders that are unusually large. They can discontinue using it at any time if their order volume declines because there is no long-term commitment involved in the process.
Who Qualifies For Purchase Order Financing?
Purchase order financing is useful for companies that need to purchase inventory to fulfill a customers ’ purchase orders but lacks liquidity or credit to do so. The types of businesses that use funding for purchase orders include:
- Startups
- Businesses with poor credit
- Wholesalers
- Distributors
- Resellers
- Importers or exporters finished products and raw materials
- Government contractors
One of the factors that determines whether your company is eligible for purchase order financing is if you sell finished goods. Purchase order financing is not available to businesses that sell raw materials or services.
How Does Purchase Order Financing Work?
Step 1- A purchase order is handed to you. A significant order is placed with your company by a client, but you don’t believe you have the stock or working capital to fulfill it.
Step 2 – You choose the price. To find out how much it is going to cost to fulfill the order, you get in touch with your supplier. You can determine whether you’ll need to submit an application for funding to satisfy the order based on the cost estimation your supplier provides.
Step 3 – You submit a financing request for a purchase order. Once you’ve made the decision that you require PO financing, you’ll need to identify the best provider, complete an application, and, ideally, be approved. As part of the application, you must also include the purchase requisition and the supplier’s estimated cost. Based on your business’s credentials, the supplier’s history and reputation, and the creditworthiness of the customer, the lending company could approve you for up to 100% of the supplier’s costs. It’s important to remember that if the lending company only approves you for a part of the financing, let’s say 90% of the costs, you’ll be on the hook for the remaining 10%.
Step 4 – Supplier payment is made by the financing company. The purchase order financing company will compensate your supplier to produce and deliver the goods required to satisfy the customer’s order once you have been given the go-ahead. A credit letter is a formal bank guarantee that the invoice will be settled once certain criteria are met. In this scenario, once the goods have been delivered and proof of delivery has been given. Many lending businesses will pay suppliers using a credit letter.
Step 5 – The products are delivered to the customer by your supplier. The merchandise is delivered straight to the customer by the supplier. The order is finished when the customer gets the products.
Step 6 – You send the client an invoice. You send the customer an invoice for their order after they’ve received the products. Additionally, you deliver the invoice to the provider of the purchase order financing.
Step 7 – The buyer reimburses the PO financing business. The full amount of the invoice is paid in full by the customer to the financing company.
Step 8 – The lending company transfers your funds after deducting its fees. The company that provides purchase order financing deducts its fees after receiving the payment from the customer and gives you the remaining amount from the proceeds.
benefits of Purchase Order Financing
- Enables you to accept large client orders that you couldn’t otherwise complete.
- It’s more readily available than other forms of business financing.
- It requires no planning for weekly or monthly loan repayments like other business loans do.
- There is no long term commitment.
- Fees are relative to the size of the purchase order costs of goods.
disadvantages of Purchase Order Financing
- Purchase order financing may be very expensive for some businesses, depending on how long your customers take to settle the invoice.
- It depends entirely on your clients. You are paid your profits and the supplier’s invoice is settled only when the client settles the invoice after receiving their order.
- Most of the process is handled by your lender and supplier and your involvement is limited. This may affect how business is conducted and your relationships with your clients.
How much does Purchase Order Financing cost?
The monthly fees for purchase order financing commonly range from 1% to 6% and are calculated on a per-thirty-day basis. These charges are determined by the total costs incurred by the supplier, and they typically rise when your customer’s invoice is unpaid for a longer period of time.
These fees might seem small. However, since they aren’t the same as the interest rates on business loans, it’s crucial to convert them into annual percentage rates in order to determine the true cost of the financing. Purchase order financing frequently has APRs that are higher than 20%.
Some companies that finance purchase orders might also employ a fee schedule. Here, you pay a set amount for the initial 30 days and thereafter pay a reduced rate for a predetermined length of time until your client pays.
For instance, a business might charge 3% every 30 days, followed by 1% every 10 days, or 3% every 30 days, followed by 0.1% every day.
The charges you pay for purchase order financing depend largely on your company’s credentials, the creditworthiness of your clients, and the standing of your vendor.
How can you qualify for purchase order financing?
Luckily, getting financing for purchase orders is not too difficult, especially if you have large purchase orders.
The following criteria are typically needed to qualify for purchase order funding:
- Selling finished products, not components or raw materials
- Market to B2B or B2G clients
- A minimum order amount of $20,000
- Profitability of at least 15% to 20%, as determined by comparing the costs of your vendors to the prices you charge your customers per transaction.
- Sell to clients who are creditworthy.
- Have reliable suppliers who can produce the products and promptly deliver them to your customers.
Here’s one of the most important things to keep in mind when using purchase order financing. The financial institution is more interested in the credit histories of your clients and suppliers than they are in your own.
Key Points
Fill larger purchase orders
Purchase order financing allows you to fill larger purchase orders without straining your cash flow.
Keep Clients Happy
Your clients rely on you to deliver on time every time. Don’t disappoint them because of cashflow issues.
Grow your revenues
Larger orders = Greater Revenue. Work with us to stop turning down large opportunities.
Red our most recent Purchase Order Financing Case Study
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Government Contractor – Funded
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PO Financing - FAQ
When placing an order, a customer creates a purchase order. The seller, on the other hand, creates an invoice after an order is finished. In short, an invoice is the documentation of a sale, whereas a purchase order signifies a sales contract.
An official offer from an intended customer to a seller is made by the issuance of a purchase order, which is a commercial document. Vendors are advised against making deliveries or sending items out before the purchase order has been issued.
This is usually not possible with any lender since the only way they settle the supplier’s invoice is through a letter of credit.
This varies from lender to lender, but most traditional lenders may take a few weeks to approve your funding. Online lenders may settle this process much faster.
No. Financing purchase order is necessary only if you have to pay a supplier for products and you don’t have the working capital needed for that. Service-based businesses don’t face this issue and are hence ineligible for PO financing.
It can be very expensive for some businesses while being the best option for others. It depends on the quality of your customers and their creditworthiness.
If you run a product-based business and are not able to meet a large purchase order due to a shortfall of working capital, you will benefit from PO financing.
Yes. It’s not mandatory for you to have a small business or startup to apply for purchase order financing.