Should Your Business Consider Purchase Order Financing?

Should Your Business Consider
Purchase Order Financing?

Fulfilling large purchase orders without enough working capital is a challenge for small businesses. If you turn customers down, your bottom line and/or business reputation will take the hit. Fortunately, there is a way to fulfill customer orders even if you don’t have sufficient capital and it’s through purchase order financing (PO financing).

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If you have open purchase orders, you can pay your suppliers to manufacture and deliver the goods you sell through PO financing. While purchase order financing is not the usual option for business owners, it can come in handy if you want to keep cash flow moving to meet customer demands.

What Exactly is Purchase Order Financing?

Purchase order financing or PO financing is what owners use to pay suppliers or vendors to fulfill customer orders. For instance, you receive a large purchase order from your client but you don’t have the means to pay your supplier for the goods. Instead of turning down profitable opportunities, you can apply for PO financing.

The transaction involves four parties: the seller of purchase orders (you), the customer, the lender, and the supplier. Once qualified, lenders will give you 90% – or even 100% – of the funding to pay your supplier. Your supplier will then process the goods and ship them out to your customer. Afterward, you can invoice your customers and have them repay the lender. After the lender takes the payment from your customer, they’ll subtract the amount you’ve borrowed plus a small transaction fee before sending the money to you.

To know if this type of financing is the best for your business, it’s important to carefully weigh the pros and cons of PO financing.

The Benefits of PO Financing

If cash flow issues hinder you from completing customer orders, purchase order financing may be your best bet. Here are some of the benefits of applying for purchase order financing.

  • Short-Term: Unlike traditional loans, PO financing doesn’t come with loan repayment terms because technically, it’s not a loan. It’s an advance against your future income. The entire underwriting process for purchase order financing is often completed within 60 days.
  • Great for Startups and Small Businesses: When applying for purchase order financing, lenders don’t require high credit rating or six-figure sales. Lenders are more interested in your customers’ creditworthiness and financial history because, after all, they’re the ones paying the bill. Since the receivables serve as collateral, you don’t have to pledge any personal guarantee.
  • No Monthly Installments: Sure, PO financing can be costly, but taking a loan from a bank will likely be twice as expensive as purchasing order financing. With traditional loans, you need to pay for monthly installments plus interest. Purchase order financing doesn’t charge monthly loan installments because, again, it’s not a loan in the first place. Instead, you only repay the amount you’ve borrowed once your customers pay you for the goods.
The Drawbacks of PO Financing

With the pros of PO financing, come the cons. To properly determine whether PO financing is good for you, consider this list of cons before applying.

  • More Expensive than Other Options: A purchase order financing could cost you around 6% per month. This rate is much higher compared to traditional loans and even loans from alternative lenders. It’s typically cheaper than invoice financing or merchant cash advances, but it’s still one of the most expensive funding options.
  • May Alienate Your Customers: Using PO financing risks alienating your customers because you don’t directly communicate with them. Once their invoices are due, they pay their dues to the financing company rather than to you. You may need to explain the scenario to your customers because many of them can do a double-take when they hear about this setup.
  • You Should Sell Tangible Products: Not everyone can qualify for PO financing, only those businesses that sell products or items. For instance, a retail store or a manufacturing company can qualify for purchase order financing, but service-based companies like an events company or transportation company wouldn’t.
Is PO Financing the Best Option for Your Business?

Even though PO financing is more expensive than traditional loans, it benefits companies with cash flow issues and poor credit ratings. It’s not a long-term funding solution, but it’s great if you need fast cash to address customer orders.

Don’t solely rely on PO financing to get your business through tough times. You can check out different types of financing solution that costs less than purchase order financing. Assess your company and check your eligibility for SBA loans, business lines of credit, and more.