Owners of mid-sized companies are probably very familiar with this theme: The company lands a huge purchase order from a large corporation or government agency with a two-month delivery timetable. It will require the immediate purchase of supplies or products and the hiring of additional workers. If the supply vendor requires pre-payment for supplies, as many do, the company would have to be able to fund the immediate costs from current cash flow; however with 60-day terms upon delivery, the gap between paying for production costs and receiving payment could be as long as 150 days, which is an eternity for a cash-strapped company. It is a continuing saga for mid-sized companies trying to get ahead in a world where it takes money to make money.

Company owners know that, if they have to pass on opportunities like that, they may not see them again. When there are insufficient cash reserves or the owners and investors are tapped out, many companies can’t even consider such an opportunity – except it they have access to a reliable source of working capital. That is why an increasing number of mid-sized wholesalers and distributors are turning to purchase order financing as the easy solution.

Purchase Order Financing as a Capital Source

Although purchase order financing has been around for decades, it was not until the financial crisis when it became more prevalent. Since then asset-based lenders have proliferated, filling the massive void left by traditional banks all but abandoned the business market in the early years following the crisis. Even today, with the strict lending requirements banks are maintaining, asset-based lending has not only become a more viable business financing alternative, it becoming a preferred alternative for a number of reasons:

  • Qualifying for an asset-based loan doesn’t depend on a company’s credit standing; rather it relies on the creditworthiness of the company’s customers.
  • Asset-based loans can be approved and advanced within days instead of weeks or months typical of traditional bank loans.
  • Asset-based loans do not require business or personal assets for collateral; instead, they are secured by the receivables or inventories of the business.
  • Companies can keep capital working in the business while using the lender’s money to cover its immediate costs.
  • Purchase order financing enables a company to accept larger and larger orders, which can accelerate its growth and profitability.

How Purchase Order Financing Works

Purchase order financing is used specifically as a capital source to pay suppliers to produce and deliver goods to be resold in anticipation of full payment by end-customers under the regular terms of their invoice. When a company receives a purchase order, the lender agrees to pay the supplier up to a certain percent of the cost of supplies using the purchase order as collateral. The purchase order might be for $100,000 in goods, but the cost of supplies to fulfill the order might only be $70,000. The lender might advance up to $50,000 or more, depending on the reputation of the supplier and the creditworthiness of the customer placing the order. When the order is delivered and the customer is invoiced, the lender collects the invoice amount based on the terms of the invoice and remits the balance to the company.

How much are the Costs?

On average, purchase order financing rates are around 3% per 30 days, prorated after the final 30 days. It can be higher or lower depending on a number of factors, such as the company’s experience in the industry, the size of the transaction, the reliability of the supplier and the creditworthiness of the customer. Purchase order financing tends to be more costly than other alternative financing options, which is why it is most suited for companies with profit margins of at least 20%.

Qualifications for Purchase Order Financing

Although companies don’t have to qualify based on their credit standing, there are a number of other factors lenders consider for qualification (these may vary depending on the lender):

  • Resold products must be finished without need for modifications
  • Gross margins should be upwards of 20% or more
  • Suppliers are reliable and financially stable
  • End-customers have a strong commercial credit standing
  • Purchase orders are non-cancelable with no consignment or guaranteed sale terms

Combining Purchase Order Financing with Invoice Factoring

Because purchase order financing tends to be more expensive than other alternative financing options, companies can lower their costs by combining it with invoice factoring or a receivable financing line. That would involve a separate transaction, for the purpose of paying off the purchase order loan with an advance on the invoice value.

  • The company fulfills the purchase order and invoices the customer.
  • The company sells the invoice to a factoring company.
  • The factoring company advances the invoice amount holding 10 to 20% in reserve.
  • The advance is used to pay off the purchase order loan.
  • When payment is received for the invoice under its original terms, the factor pays the company the reserve balance less a 1 to 3% factor fee.

Alternatively, the company could establish a receivables line of credit to finance the invoice, Either way, a company would have to consider all of the costs involved in the two transactions to determine if it would be more cost effective.

With purchase order financing, a company can pursue larger orders and new customers with confidence. Although it is not an inexpensive form of financing, it can be invaluable in providing a fledgling mid-sized company with a stepping stone to more growth opportunities. When combined with less expensive asset-based financing methods, such as receivables financing, it can ensure the company has sufficient working capital to stay on a growth path.