Everything You Need to Know About Purchase Order Financing
Is your business considering purchase order financing? In this guide you will learn what purchase order financing is and how it works step by step. We’ve helped hundreds of business owners receive up to $200,000 in quick funding. See if you qualify instantly online with no fees, obligations or impact to your credit.
Purchase order financing helps businesses access extra working capital to purchase supplies in bulk at wholesale prices, increase their inventory, and accelerate business growth. For newly established companies or companies that experience an unexpected surge in customers, extra cash may not be readily available to purchase the large volume of supplies required to fulfill orders.
Purchase order financing also helps businesses retain their customer base by providing solutions to internal cash flow problems. Below you will learn how purchase order financing works, the pros and cons, as well as additional information you may find helpful.
What Is Purchase Order Financing?
Purchase order financing companies pay suppliers upfront for the cost of manufacturing and shipping customer purchase orders. Customers pay purchase order financing companies for orders directly, who then subtract any fees associated with the financing agreement before forwarding the rest of the money to the borrower. Borrowers can either be individuals or businesses.
How Does Purchase Order Financing Work?
1. You Receive a Purchase Order
A purchase order will come in from a customer that specifies how much of a given product or supplies they would like to purchase from you. Based on the size of the order, you should have a rough idea of whether or not you will be able to fulfill the order on your own.
2. Your Supplier Will Estimate Your Costs
Once you receive a customer’s purchase order, you can estimate supplier costs. The standard procedure is to contact your supplier to get an invoice for how much the customer’s order will cost. Having a realistic price will help you decide to pay the supplier on your own or use purchase order financing to float the cost.
3. Apply for Purchase Order Financing
Purchase order financing is obtained by an outside lender who specializes in purchase orders. Application approval is generally based upon supplier reputation, creditworthy customers, and your own qualifications as a seller/borrower. Funding can be approved for amounts up to 100% of the supplier invoice depending on application strength.
4. The Lender Pays Your Supplier
After an application is approved, the purchase order financing company pays the supplier for your customer’s order. If you didn’t get approved for 100% of the supplier’s invoice amount, you would have to come up with enough cash to pay the difference. Once the supplier gets paid, they can work on fulfilling your customer’s order.
5. The Supplier Delivers the Goods to Your Customer
Once the supplier completes your customer’s order, the supplier will ship the requested items directly to your customer. You will receive notification from the supplier once a delivery is made.
6. You Invoice Your Customer
Send your customer an invoice for payment as your normally would, but they do not pay you directly.
7. The Customer Pays the Lender
When your customer pays the invoice, they will pay the purchase order financing company directly. If there is an agreement for a payment plan with the customer, you might want to consider invoice factoring as a way to get your money faster.
8. The Lender Forwards Your Money to You
Once your customer pays the purchase order financing company, funds will be forwarded to you. The amount you receive will be less than the customer’s original invoice value due to lending fees. Any applicable fees will be deducted before receiving your portion of the funds.
Purchase Order Financing Interest Rates
Purchase order financing fees generally range from 1.8-6%. Interest begins accruing the day your supplier receives payment from the lender. Therefore, if your supplier takes a long time to fill the customer’s order or the customer takes a long time to pay the lender, fees can quickly add up.
Pros and Cons of Purchase Order Financing
Advantages of Purchase Order Financing
Easy to Qualify: Purchase order financing agreements offer companies an advance on supplier costs. Because it is not a loan, PO financing companies have more flexible funding requirements.
No Long-Term Payment Plans: You get paid when the customer pays the lender. No long-term payment plans or additional outstanding debt can make managing business finances easier.
No Collateral or Personal Guarantee Required: Your personal assets are not at risk with purchase order financing since a customer’s invoice secures the financing agreement.
No Exclusions for Bad Credit: Purchase order financing relies more on a customer’s credit score and on-time payment history than yours. So while a lender may check your credit during the application process, it carries far less weight than with banks or credit unions.
Disadvantages of Purchase Order Financing
Only Some Business Types Are Eligible: Businesses that have physical products are eligible for purchase order financing. Unfortunately, this means that all service-oriented businesses are excluded.
Higher Fees Than Loans: Monthly fees can range from 1.8-6% for purchase order financing. Interest begins to accrue the day the supplier gets paid by the lender. If the supplier takes a long time to fulfill or ship the order or if the customer takes their time paying the lender, your fees will significantly increase. Since you don’t get paid until the lender gets paid, this dramatically reduces your cut.
You May Not Get 100% Approval: The most common approval amounts for purchase order financing requests are 80-90%. You will have to come up with the difference in cash in order to pay the supplier.
Your Customers Will Know You Need Outside Financing: Because customers are paying the lender directly, they will be made aware that a financing company was used to fulfill their order. This may jade your company’s reputation in the eyes of some customers.
Purchase Order Financing vs. Short-term Loans
Short-term loans are traditional installment loans that release a lump sum of money upfront in exchange for repayment via fixed monthly amounts over a specified period of time. Term loans often require a good credit history in order to get approved but may offer lower rates than purchase order financing agreements.
Purchase Order Financing vs. Invoice Factoring
Purchase order financing and invoice factoring may appear similar but are somewhat different.
A lender pays a supplier to fulfill a customer’s order with purchase order financing. After the supplier completes and delivers the customer’s order, you invoice the customer, and the customer pays the lender directly. Once the customer pays the lender, fees are deducted, and the remaining balance is forwarded to you from the lender. You don’t get paid until the lender gets paid.
With invoice factoring, you fulfill the customer’s order and send them an invoice. The customer’s invoice is then sold to a lender at a reduced rate in exchange for cash upfront. The lender is then responsible for collecting payment from the customer. You get paid no matter when the lender gets paid.
Purchase Order Financing vs. Invoice Financing
The main difference between purchase order financing and invoice financing is when you get paid and who is responsible for collecting payment.
With purchase order financing, you get paid after the supplier fills the order, and the lender gets paid. The lender is responsible for collecting payment from the customer. With invoice factoring, you get paid upfront for the discounted value of the invoice. You are responsible for collecting payment from the customer.
Purchase Order Financing Frequently Asked Questions
Yes. Purchase order financing is much easier to qualify for than a loan from a traditional financial institution. Lenders are much more concerned with customer credit profiles and on-time payment histories than yours since the customer will be paying the lender directly. In addition, a customer’s purchase order serves as collateral for the financing agreement.
Yes, however lenders may offer a reduced amount to offset their risk. But startup businesses can rely on purchase order financing to help fill customer orders during the early stages of growth.
Companies that sell completed products but cannot afford to purchase supplies outright can benefit from purchase order financing arrangements. Financing helps to cover gaps in cash flow during seasonal increases in sales or unexpected surges in business.
Not technically. Purchase order financing is a flexible option for funding that allows companies to receive an advance on customer purchase orders during periods of decreased cash flow.
Sometimes. If you have a longstanding relationship with a banking institution, they may fund your request for purchase order financing, although it is unlikely. Purchase order financing is usually obtained from alternative lenders.
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Purchase Order Financing in Summary
Qualifying for purchase order financing is more straightforward than traditional installment loans for startups and business owners who have not yet developed strong credit histories.
For certain businesses, purchase order financing may be a flexible option for fulfilling customer orders during periods of interrupted cash flow or seasonal spikes in sales. Determining which financing option is right for you will depend on your company’s individual needs and circumstances.
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