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Purchase order (PO) financing is a way for resellers that lack the cash flow to buy the inventory to complete customer orders. The PO financing company will pay the supplier to deliver the goods to the customer. The customer then pays the PO financing company directly. The PO financing company then deducts its fees and sends the rest to the reseller.
PO financing can be used to finance an upcoming order. After an order has been fulfilled, the business can sell the invoices for the fulfilled order at a discount to a factoring company or a bank. With factoring, a business can obtain working capital in as little as 24 to 48 hours. To learn more about factoring, please visit our pages for Small Business Factoring or Invoice Factoring.
Most factors buy your invoices on a recourse basis. This is similar to a short-term loan, because if your customer does not pay, the invoice is charged back to you. By comparison, Business Factors buys your invoices outright—through a process known as non-recourse factoring—so that you are not charged if the invoice is not collected. A business can factor all or just one of its invoices through something known as spot factoring.
This process is called simply “factoring.” “Purchase order factoring” is an inaccurate term that conflates purchase order financing with factoring.
To be eligible for PO financing, transactions should be recurrent, be for a minimum of $50,000 and be non-cancelable with a margin of at least 20%. PO financing is generally only available to cover straight resale transactions, not the manufacturing of goods.
The criteria will vary amongst PO companies, but in general financing providers will look for for the transaction to meet the following criteria:
- A recurring transaction of at least $50,000. PO companies minimize their risk by not underwriting first-time transactions. Smaller transactions require as much due diligence as bigger ones, so PO companies set a threshold amount.
- Non-cancelable with a minimum margin of 20%. The margin requirement ensures that after paying the PO company’s fees—and possibly a factoring company’s fees as well—the reseller still makes a profit. No financing company wants to be responsible for putting another company in the red.
- Not a guaranteed or consignment sale. Goods purchased under these arrangements can be returned, which can eat into reseller’s—and PO financing company’s—margins.
- A purchase of finished goods, not goods that have yet to be manufactured. Many PO companies will only fund straight resales, with no modifications, to lower risks.
- Domestic, unless the company accepts international transactions. Some companies will only underwrite domestic deals, while others will be open to working with overseas businesses. Contact one of our executives today to see what the best alternative to finance your business is.
PO financing can be structured in many different ways, depending on (a) the financing companies involved, (b) the industry and the location of the buyers, resellers and suppliers and (c) the timing of the transaction, among other factors. The basic premise of any PO transaction is that a reseller does not have the funds to fulfill an order from a customer.
A sample PO financing transaction could work in six steps:
- A reseller gets a purchase order from a customer.
- A PO financing company verifies the order and agrees to cover all or a part of the reseller’s costs.
- The PO financing company issues a letter of credit (L/C) to the reseller’s supplier or pays for the order directly.
- The supplier ships the goods to the end customer.
- The customer pays the PO financier in the allotted time frame (such as 60 days).
- The PO financing company substracts its fees and sends the reseller the remainder of the payment minus its fees.
Alternatively, a factoring company may be used at #5 to reduce or eliminate the time that the reseller has to wait for the invoice to be paid. Getting paid faster allows the reseller to reinvest the money into its business or fund another large order.
In a PO transaction, a PO financing company pays a reseller’s supplier directly to ship the goods to the end customer. The end customer then pays the PO financing company. The PO financing company deducts its fees and sends the remainder of the money to the reseller
Let’s take a look at an example of a US-based chemicals reseller who just received a $500,000 order from an international oil company.
Both the reseller and the supplier are located in Canada but have not done business together before. The reseller was promised additional business if it fulfills the order within a specified deadline, but it lacks the financial capacity to do so.
- Purchase order (PO) amount: $500,000
- Cost of supplies: $350,000
- PO fee: 10% of the PO amount
- Payment terms: Net 90 days
The PO financing company issues a letter of credit (L/C) for $500,000 to the supplier’s bank to guarantee payment.
Once the goods are shipped, the supplier provides proof to its bank. The supplier’s bank then forwards the proof to the bank that issued the L/C to obtain payment. L/Cs are legally binding and are often used in the cross-border transactions or when the parties have not done business together before.
Once the order has been fulfilled, the customer pays $500,000 to the PO financing company.
The PO financing company pays the supplier $350,000. From the remaining $150,000, it subtracts its 10% fee ($50,000) and forwards what’s left ($100,000) to the reseller as its profit.
Alternatively, instead of waiting for 90 days, the reseller may choose to factor the invoice. In that case, the factoring company pays the PO company $350,000, holds a percentage of the invoice as reserve and advances the reseller the rest. Once the invoice is paid, the reserve—minus the factoring company’s fee—is returned to the reseller.
As part of the qualification process, the PO financing company typically reviews the credit profile and track record of other parties involved in the transaction:
- The end customer. The credit profile of the final client is important since it is the party paying for the transaction. PO financing companies are likely to run a credit check on the end customer.
- The supplier. The financier will evaluate the credit profile of the suppliers. It helps if they are well-established companies with a good track payment record, no recent bankruptcies and no history of serious litigation. Some PO financing companies will not finance a transaction if the supplier is experiencing financial problems or needs an advance to fund production.
- The reseller. The reseller’s ’s financial situation is important to ensure that it has the ability to fulfill the order if the supplier funding is extended. The PO financing company will review public records to ensure that the reseller does not have serious tax or legal problems. The reseller’s individual credit score is less important, since the financing mostly relies on the creditworthiness of the end customer. Owners of resellers that do have a history of similar transactions might be required to sign a personal guarantee and may have their credit checked.
The PO financing process should begin as soon as possible, especially for complex international transactions.
If a reseller thinks he or she might need PO financing, it is best to start the process as early as possible. In fact, a running joke in the financing industry is that a business should look for PO financing before it needs it.
This is because in many cases PO financing is done for complex – often cross-border transactions—and due diligence and structuring for such deals can take some time. Contact Business Factors & Finance today to get started.
PO financing is typically extended to a reseller’s suppliers to cover the cost of inventory for a large order. It is not usually used to cover production costs or cover supplier’s cost of manufacturing the goods. Once the goods are shipped, the end customer pays the PO financing company directly, and the PO financing company deducts its fees before sending the rest to the reseller. End customers’ credit profiles and suppliers’ and resellers’ financial situations are factors taken into consideration by a PO financing company. To be eligible for PO financing, transactions should be recurrent, a minimum of $50,000 and non-cancelable, with a margin of at least 20%. PO financing can be combined with factoring— sale of invoices to a factoring company—to eliminate or reduce the wait for the end customer to pay the receivable. A reseller should start the PO financing process as soon as possible, especially in the case of a complex, international transaction. Contact one of Business Factors’ executives today to understand more about how the process works and to get a quote.
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