Think you are ready to get your small business off the ground? Even with a rock-solid product, it can be difficult to secure the funds necessary to pay off your supplier to meet the demand of incoming customers.
60% of small businesses struggle with cash flow every month. This is why PO financing is an excellent option for young companies looking for solutions to fit their financial needs.
In this article, we will cover everything you need to know about purchase order financing in an effort to help business owners like yourself manage cash flow within the business supplier transaction.
We will first discover what purchase order financing is and who it benefits. Then, we’ll go more in-depth by exploring exactly how to use purchase order financing to help your business, as well as discuss some alternative methods of receiving financing for your company.
What is Purchase Order Financing?
Purchase order financing, sometimes referred to as ‘PO financing,’ is a way for businesses that lack the funds necessary to pay off their supplier to finance payments to their supplier.
A business uses purchase orders to notify its supplier of the goods it will need to do business with potential customers. Often, small businesses lack the funds necessary to fill the onslaught of customer orders, or in some cases, one large order will be too expensive to pay off.
Let’s take a look at an example. John is starting a new clothing company and just received his first major customer in the form of a large department store. John has been making and selling T-shirts at two smaller local stores up until now and sees this large department store as a chance to expand.
However, he lacks the funds necessary to pay the supplier for an order of this size. With purchase order financing, John can now guarantee his customer’s orders will be shipped on time before having the funds necessary to pay the supplier in full.
Who’s Who in PO Financing?
Before jumping into the steps of going about financing your purchase orders, it is important to understand the four parties involved. PO Financers, Assemble!
- The borrower or seller – The person in need of a loan to start doing business
- Purchase order financing company – A lender in charge of providing the payment to the supplier
- The supplier – The company tasked with supplying goods to the customer
- Customers – The person or persons making the order from the borrower or seller
Step By Step Guide To PO Financing
Now that we’ve broken down the basics of what’s involved in PO Financing, It’s time to determine whether or not you need a financier in the first place? Upon receiving a customer order, you will need to figure out how much the supplier will charge to fulfill this order.
If you cannot pay the supplier in full of fulfilling the order, you will know it is time to contact a third-party lender.
Applying for PO Financing
The first step in this process will be to apply for the loan via the purchase order financing company. You may be wondering how difficult it is to get approved for this loan. This varies as each company has different criteria for approval; however, companies that qualify for purchase order financing typically share the following characteristics.
Often, simply having a supplier will further increase your chances of being approved. If your business acts as its supplier, however, it will lessen your chances for approval.
In addition, your gross margin for the transaction should typically be around 20% as most finance companies won’t provide PO finance to companies who are unable to deliver items on orders less than $50,000.
Some financing companies will go so far as to do a credit check on the customer to ensure the customer is trustworthy and able to pay for the business.
Suppose the customer has a history of timely payments. In that case, that may be enough to ensure trust with the financing office. The borrower/business owner and supplier will also need to trust past orders’ trusty reputation or prove good financial standings.
If your business meets all the criteria listed above and intends to do business with reputable suppliers and customers, you will most certainly be approved for purchase order financing. The lender can approve 100% of the payment but often approves around 80%-90%, depending on your approval ratings.
Once You’ve Been Approved
The finance company will pay the supplier the agreed-upon percentage. If it is under 100% you, the business will cover the remainder of payments needed to pay off the supplier fully. Once the supplier is paid off, they will ship the goods directly to the customer. You will not act as a middle man in the transfer of goods since you took out a loan to pay the supplier.
Now that the supplier has shipped the goods, they will make you, the business owner, aware, and the customer is responsible for payment. If the customer wants to pay over a set time, the lender can actually purchase the invoice from you. This is called invoice factoring or factor lending and offers you a chance to access your funds quicker at the cost of lower fees.
Either way, you will not be directly paid by the customer. In fact, the customer will pay off the finance company directly. The faster they pay their order off, the quicker you will receive your funds. Once the customer fully pays off the finance company, they will be responsible for forwarding you your share of the profit once they deduct the fees for the loan in the first place.
Who Benefits From PO Financing?
Let’s take a moment to go over who is eligible to benefit from this process. As stated above, any company that needs help paying their supplier upon receiving a big order from a customer should consider PO financing. Common companies that have been known to receive help from PO financing are as follows:
- Government Contractors
If you find yourself on this list, you may be in the right position to apply for purchase order financing.
The Positives of PO Financing
The most obvious pro to using PO financing is that it gives your business the ability to complete large orders you otherwise would not have been able to fulfill.
Secondly, an important distinction to make about PO Financing is that it is not a loan. Therefore you won’t need to make monthly installments to pay it off. Instead, the fee will come directly out of the transaction itself.
As a result, the PO office will be extremely invested in making sure your customer fulfills their payment on time, taking the burden off your company.
The Negatives of Of Purchase Order Financing
The biggest downside of using a purchase order is the costs that your company will have to pay. You will need to pay a fee to the finance company, which can oftentimes be quite substantial.
On average, it can range from 1.8% to 6% each month. Furthermore, since the customer is directly paying the financier, the customer may have the ability to calculate your cash flow struggles, something that might hurt your relationship with this customer in the long run.
Additionally, most finance companies are unwilling to finance small orders, meaning your company will need to bring in a large order or lump together several small orders in order to secure funding from a finance office.
Finally, if your company is service-based, you will need to look for different financing options as PO financing only works for product-based businesses.
Final Thoughts On Small Business Financing
Not fully convinced purchase order financing is the right tool to grow your business? It may be valuable to know that there are plenty of other finance options for you and your business. Some alternative finance options include:
- Merchant Cash Advances – Businesses with a lot of credit card transactions can apply for a cash advance in exchange for a percentage of future credit card payments
- Traditional Term Loans – Using a bank to receive a loan for your small business
- Outside Investors – Taking on debt or giving away equity in your business by taking outside investment or bringing on a partner.
Consequently, purchase order financing is not the only option for financing your company but can serve as a great tool for the right company.
Backed with the proper knowledge and a strong business plan, your company has the opportunity to expand and succeed with the help of a Purchase Order Financing company.