Businesses fail for a myriad of reasons. Of the leading causes, ineffective management of cash is a major one. It stunts business growth and leads to unaccountability. In the end, accounts never balance and there’s never room for growth. From there, it's mostly a downward slope.
If your business has been facing this, don’t fret. There’s a solution. Purchase Order financing (POF).
When done right, it helps businesses fulfill large orders, manage cash flow effectively, build stronger supplier relationships, seize sales opportunities, and mitigate risks.
And that’s what you’re going to learn from this guide. How purchase financing works, best practices, choosing the best partner and how to choose the best provider for you.
Let’s go.
Understanding Purchase Order Financing
What is purchase order financing?
Purchase Order Financing, also known as PO Financing or POF, is a financial arrangement where a third-party lender provides funds to a business to fulfill purchase orders from customers. It is a short-term financing solution that helps businesses manage cash flow gaps that can occur when they receive large orders but lack the necessary funds to fulfill them.
Key concepts Explained
1. Purchase Orders
A purchase order is a document issued by a customer to a supplier, outlining the details of a requested order, such as the quantity, description, and agreed-upon price of the products or service.
For example, if a clothing retailer submits a purchase order to a clothing manufacturer for 500 units of a specific dress style, specifying the sizes, colors, and agreed-upon price per unit.
2. Supplier and Reseller
You probably have a faint idea of who a supplier and reseller are. Someone who supplies goods while the reseller just sells the purchase order. But a real example is fitting to create the perfect picture.
So imagine that a tech company receives a purchase order from a large electronics retailer for 1,000 units of their latest smartphone model. The tech company is the supplier responsible for manufacturing and delivering the smartphones. The electronics retailer is the reseller who secured the purchase order from their customers and will sell the smartphones in their stores.
3. Funding Provider:
The funding provider is the third-party lender, such as a financial institution or specialized purchase order financing company, that provides the necessary funds to the business to fulfill the purchase order. The funding provider may also assist with managing the collection of payments from the customer.
For example, a small toy manufacturer receives a purchase order from a national toy store chain for a large quantity of their toys. Since the toy manufacturer lacks the necessary funds to fulfill the order upfront, they seek purchase order financing from a specialized funding provider. The funding provider reviews the purchase order, assesses the creditworthiness of the toy store chain, and provides the required funds to the toy manufacturer to produce and deliver the toys.
How does Purchase Order Financing Work?
The process of purchase order financing involves the following steps:
1. Purchase Order Evaluation: The reseller submits the purchase order to the funding provider for evaluation. The funding provider assesses the creditworthiness of the customer, the reliability of the supplier, and the profitability of the transaction.
2. Funding Approval: If the purchase order meets the criteria set by the funding provider, they approve the financing request. The financing amount is usually a percentage of the total value of the purchase order.
3. Funding Transfer: Upon approval, the funding provider transfers the agreed-upon funds directly to the supplier or pays the supplier on behalf of the reseller. This enables the supplier to fulfill the order by manufacturing or sourcing the required products.
4. Shipment and Delivery: The supplier manufactures or procures the products and ships them directly to the customer as specified in the purchase order.
5. Invoice and Collection: Once the products are delivered, the reseller generates an invoice and sends it to the customer. The customer then makes a payment to the reseller or directly to the funding provider.
6. Repayment: The reseller repays the funding provider, usually from the proceeds received from the customer's payment. The repayment amount includes the financing fees or interest charged by the funding provider.
Benefits and Advantages of Purchase Order Financing
1. Improved Cash Flow
PO Financing provides the necessary funds to fulfill purchase orders, enabling your business to avoid cash flow constraints and seize growth opportunities. It bridges the gap between your supplier's need for upfront payment and the reseller's ability to pay after delivering the goods.
2. Increased Sales and Market Share
By having access to financing, you can accept and fulfill larger orders from customers. This ability to handle bigger contracts can lead to increased sales, enhanced customer satisfaction, and potentially greater market share.
Kayode Usman, of Onoraus enterprises business tried it with us and this is their testimony
3. Supplier Relationships
Purchase order financing can strengthen relationships with suppliers. With assured payment, you can negotiate better terms, discounts, or prioritize orders, which can improve the overall supply chain management.
4. Flexible Financing Option
Purchase Order Financing is often more accessible than traditional loans, especially for businesses with limited credit history or a short operating history. The financing decision is primarily based on the creditworthiness of the customer and the viability of the purchase order.
Our monthly collection cycle is now far more efficient. We no longer waste days in the bank looking for Purchase financing. Bridger is all online
Thomas Adamsons
Misconceptions about Purchase Order Financing
1. Purchase Order Financing is the Same as Invoice Financing
No, It is not. While both Purchase Order Financing and Invoice Financing are short-term financing options, they serve different purposes. Purchase Order Financing provides funds to fulfill the purchase order, whereas Invoice Financing involves borrowing against invoices that have been issued but not yet paid.
2. Only Startups or Small Businesses Use PO Financing
No. Purchase Order Financing is suitable for businesses of all sizes. While it can be beneficial for startups and small businesses, larger companies can also utilize PO Financing to manage cash flow fluctuations during periods of rapid growth or when fulfilling unusually large orders.
3. Purchase Order Financing is Expensive
No. While Purchase Order Financing may involve higher costs compared to traditional loans, the fees are typically based on the risk and complexity of the transaction. The benefits and potential revenue generated from fulfilling larger orders often outweigh the financing costs. It's essential for businesses to evaluate the overall financial impact before dismissing PO Financing solely based on cost.
In doubt? Try us out.
Eligibility Criteria for Businesses
Common eligibility requirements include:
1. Established Business: Most funding providers prefer to work with businesses that have a track record and a proven history of successful operations.
Ladipo Lawani of L&L foods is an example of this. They are already established and decided to use us. It was a seamless process.
2. Purchase Order Contracts: Your business should have purchase order contracts from creditworthy customers. The creditworthiness of the customer plays a significant role in the approval process.
3. Profit Margins: The profitability of the transaction is a crucial consideration. Funding providers assess the profit margins to ensure that the transaction will generate sufficient returns to cover the financing costs.
4. Supplier Capability: The ability of the supplier to fulfill the purchase order is important. Funding providers evaluate the supplier's capacity, reliability, and ability to deliver the products or services in a timely manner.
Types of Purchase Orders Suitable for Financing
1. Finished Goods: Purchase orders for finished goods, such as manufactured products or goods that are ready to be shipped, are typically easier to finance compared to orders for raw materials or goods in the production process.
2. Non-Cancellable Orders: Purchase orders that are non-cancellable and legally binding offer greater security for funding providers. Orders that can be easily canceled or modified may be less favorable for financing.
3. Creditworthy Customers: Purchase orders from customers with a strong credit history and reputation are more likely to be considered for financing. The creditworthiness of the customer helps mitigate the risk for the funding provider.
Evaluating the Viability of Purchase Orders
Before approving purchase order financing, funding providers assess the viability of the purchase orders. Some factors they consider include:
1. Profitability: Funding providers evaluate the profit margins associated with the purchase orders. They assess whether the transaction will generate sufficient profit to cover the financing costs and provide a reasonable return for the business.
2. Order Size: The size of the purchase order is important. Larger orders may have a higher chance of being approved for financing, as they often offer greater revenue potential.
3. Customer Creditworthiness: The creditworthiness of the customer is a critical factor. Funding providers review the customer's payment history, financial stability, and credit rating to assess the likelihood of timely payment.
4. Supplier Capability: The funding provider evaluates the supplier's capacity to fulfill the order. They consider factors such as production capabilities, inventory management, and reliability in delivering the goods or services on time.
What are the costs and fees involved in Purchase Order Financing?
1. Financing Fee: This fee is typically a percentage of the total value of the purchase order. It covers the cost of financing and the risk undertaken by the funding provider.
2. Transaction Fees: Some funding providers may charge additional transaction fees for services such as credit checks, due diligence, and administration.
3. Late Payment Fees: If the customer payment is delayed beyond the agreed-upon terms, funding providers may charge late payment fees or penalties.
Risks and Challenges Associated with Purchase Order Financing
1. Customer Non-Payment: If the customer fails to pay the invoice, the business may still be liable for repaying the funding provider. This risk can affect the profitability of the transaction and potentially strain the business's cash flow.
2. Supplier Performance Issues: If the supplier encounters production delays, quality issues, or fails to deliver the goods as agreed, it can disrupt the fulfillment process and impact the business's ability to meet customer expectations.
3. Customer Relationships: In some cases, involving a funding provider in the fulfillment process may affect the direct relationship between the business and its customers. The customer may be aware of the financing arrangement, which can impact their perception of the business.
4. High Financing Costs: Purchase order financing typically comes with higher costs compared to traditional loans or other financing options. It's important to carefully consider the financial implications and ensure that the profitability of the transaction justifies the expenses associated with the financing.
Businesses should assess these risks and challenges before opting for purchase order financing and consider alternative financing options if the associated risks outweigh the benefits.
How to Find the Right Purchase Order Financing Provider
When searching for a purchase order financing provider, conducting thorough research is crucial. Here are some steps to consider:
1. Online Search: Start by conducting an online search for purchase order financing companies. Look for providers with a strong online presence and a clear description of their services.
2. Industry Associations: Explore industry associations or networks that specialize in financing or supply chain management. These organizations may have directories or resources that can help you identify reputable financing providers.
3. Referrals and Recommendations: Seek recommendations from trusted business partners, colleagues, or industry contacts who have previously used purchase order financing. Their insights can provide valuable guidance.
I found Bridger on LinkedIn through the CEO’s posts. A huge portion of my business’s invoicing and payments is via through the platform.
Ifeyinwa Nana
Factors to Consider When Choosing a Provider
- Providers Capacity.
This includes:
- Expertise and Specialization: Look for providers with expertise and experience in purchase order financing specifically. They should understand the unique dynamics of this financing method and be familiar with your industry or niche.
- Funding Capacity: Assess the provider's funding capacity. Ensure they can accommodate the size and volume of your purchase orders. A provider with limited funding capacity may not be able to support your business growth.
- Terms and Flexibility: Evaluate the provider's financing terms and flexibility. Consider factors such as repayment terms, interest rates, and any potential penalties or fees. Look for providers that offer flexibility in adapting to your specific business needs.
- Customer Service and Communication: Consider the provider's customer service and communication practices. Prompt and transparent communication is essential for a smooth financing process. Look for providers who are responsive and proactive in addressing your inquiries.
- Provider's Experience and Track Record
Assess the experience and track record of potential purchase order financing using the following parameters:
- Years of Operation: Consider how long the provider has been in business. Providers with a longer track record may have more experience and stability in the industry.
- Client Portfolio: Inquire about the provider's client portfolio. Find out if they have worked with businesses similar to yours or within your industry. This can indicate their understanding of your specific needs and challenges.
- Success stories and Testimonials
Ask the provider for success stories or case studies showcasing their past financing transactions. Reviewing these examples can help you gauge their ability to deliver successful outcomes.
You can also get valuable insights into the provider by checking online review websites or forums, for reviews and ratings of the financing provider. Pay attention to overall satisfaction, transparency, and any recurring concerns mentioned by previous clients.
You should also request testimonials or references from the provider. Reach out to these clients directly to inquire about their experience working with the provider. Ask about the provider's professionalism, reliability, and responsiveness.
4 Steps in Applying for Purchase Order Financing
- Gathering Required Documents and Information
To begin the application process for purchase order financing, you'll typically need to gather the following documents and information:
- Purchase Orders: Collect copies of the purchase orders you intend to finance. These should include all relevant details, such as customer information, order quantities, product descriptions, and agreed-upon prices.
- Customer Information: Provide information about the customers who issued the purchase orders. This may include their contact details, creditworthiness, and any existing business relationship you have with them.
- Supplier Information: Gather information about your suppliers, including their contact details, capabilities, and track record in fulfilling orders.
- Financial Statements: Prepare your financial statements, including balance sheets, income statements, and cash flow statements. These documents help the funding provider assess your business's financial health and viability.
- Business Documentation: Provide necessary business documents, such as articles of incorporation, business licenses, and tax identification numbers.
- Filling out the Application Form
The application form may require information such as:
- Business Information: Provide details about your business, including its legal name, address, contact information, and industry.
- Ownership and Management: Share information about the ownership structure and key members of management, including their names, roles, and experience.
- Financial Information: Disclose financial details, including revenue, profit margins, and outstanding debts. You may also need to provide information about your banking relationships.
- Funding Request: Specify the amount of funding you are seeking and provide details about the purchase orders you want to finance.
- Submitting the Application and Documentation
Once you have completed the application form, submit it along with the required documentation to the purchase order financing provider. The provider will typically specify the preferred method of submission, which may include online platforms, email, or physical mail.
Ensure that all the information provided is accurate, complete, and supported by the necessary documentation. Review the application and documents before submission to minimize errors and improve the chances of a smooth evaluation process.
- Provider's Evaluation and Decision-making Process
The evaluation process may involve the following steps:
- Document Review: The provider will review the application form and supporting documentation to ensure all necessary information is provided and accurate.
- Due Diligence: The provider may conduct due diligence to verify the authenticity and validity of the purchase orders, assess the creditworthiness of the customers, and evaluate your business's financial stability.
- Risk Assessment: The provider will assess the risk associated with financing your purchase orders. This may include evaluating factors such as profit margins, customer payment history, and the supplier's capability to fulfill the orders.
- Decision-making: Based on the evaluation, the provider will make a decision regarding your application. They will consider factors such as the viability of the purchase orders, your business's creditworthiness, and their own risk appetite.
4 Best Practices for Successful Purchase Order Financing
- Establish Strong Relationships with Suppliers
- Cultivate open lines of communication with suppliers to ensure smooth transactions.
- Build trust and reliability by consistently fulfilling orders and paying invoices on time.
- Negotiate favorable payment terms to maximize your cash flow and leverage your relationship with suppliers.
- Maintain Accurate and Updated Financial Records
- Keep meticulous records of all financial transactions related to purchase order financing.
- Regularly update your financial statements, including income statements, balance sheets, and cash flow statements.
- Use accounting software or hire a professional to manage your financial records effectively.
- Effective Communication with the Purchase Order Financing Provider
- Keep your purchase order financing provider informed about your business activities, such as new orders, changes in demand, or potential delays.
- Provide timely and accurate information required by the financing provider, such as purchase orders, invoices, and shipping details.
- Address any concerns or issues promptly to maintain a strong working relationship with the financing provider.
- Efficient Order Fulfillment and Delivery
- Streamline your order fulfillment process to minimize delays and errors.
- Ensure efficient inventory management to meet customer demand and avoid stockouts.
- Optimize your logistics and shipping operations to ensure timely delivery of orders.
4 Alternatives to Purchase Order Financing
1. Traditional Bank Loans: B2B businesses can approach banks for term loans or lines of credit based on their creditworthiness and collateral.
2. Invoice Financing: Instead of financing purchase orders, businesses can leverage their accounts receivable by selling invoices to a financing company at a discount.
3. Business Credit Cards: Business owners can use credit cards to cover short-term financing needs, but it's important to manage credit card debt and interest rates.
4. Trade Credit: Negotiate longer payment terms with suppliers, allowing you to delay payment while still fulfilling customer orders.
They’re not without pros and cons. Here are some:
The Pros and Cons of business financing options
Traditional Bank Loans
Pros: Lower interest rates, longer repayment terms, and potential relationship-building with a bank.
Cons: Stringent qualification requirements, a lengthy application process, and the need for collateral or personal guarantees.
Invoice Financing
Pros: Quick access to cash, no need for collateral, and flexibility based on sales volume.
Cons: Higher costs compared to traditional loans, Credit is tied to already delivered goods, Potential customer relationship management issues, and Reliance on customer creditworthiness.
Business Credit Cards:
Pros: Convenient and fast access to funds, potential rewards or cashback benefits, and flexibility for small expenses.
Cons: Higher interest rates, potential for overspending, and limited credit limits
Trade Credit:
Pros: Extended payment terms, potential discounts for early payment, and no need for external financing.
Cons: Limited to existing supplier relationships, potential strain on cash flow if payment terms are too long, and limited flexibility for sourcing from new suppliers
FAQs.
- What is purchase order financing?
Purchase order financing is a short-term funding option that helps businesses fulfill customer orders by providing capital to pay suppliers and cover production costs.
2. How does purchase order financing work?
Purchase order financing works by a financing provider paying suppliers directly or providing a letter of credit, allowing businesses to fulfill orders. The financing provider then collects payment from the customer directly or through accounts receivable financing.
3.What types of businesses can benefit from purchase order financing?
Various businesses can benefit from purchase order financing, including wholesalers, distributors, resellers, and manufacturers.
4. What are the requirements to qualify for purchase order financing?
The requirements to qualify for purchase order financing typically include a strong purchase order from a creditworthy customer, a reliable supply chain, and a viable profit margin.
5. How long does it take to secure purchase order financing?
The time to secure purchase order financing can vary based on factors such as the complexity of the transaction, documentation requirements, and the responsiveness of all parties involved. It can range from a few days to a couple of weeks.
6. What are the costs associated with purchase order financing?
The costs of purchase order financing include fees charged by the financing provider, which can be a percentage of the purchase order value or a factor rate applied to the funding amount.
7. How does purchase order financing impact relationships with suppliers and customers?
Purchase order financing can strengthen relationships with suppliers by ensuring timely payments, and with customers by enabling consistent order fulfillment. However, it's essential to communicate transparently with both parties about the financing arrangement.
8. What happens if a customer doesn't pay their invoice?
If a customer doesn't pay their invoice, it depends on the specific terms of the purchase order financing agreement. The financing provider may work with the business to resolve the issue or seek recourse through the business's accounts receivable.
9. Can businesses use purchase order financing for international transactions?
Yes, purchase order financing can be used for international transactions, although additional considerations such as currency exchange rates, customs requirements, and international shipping logistics may apply.
10. Is purchase order financing the same as factoring?
Purchase order financing and factoring are related but distinct financing options. While both involve leveraging customer orders or invoices, factoring involves selling accounts receivable at a discount, whereas purchase order financing focuses on funding the purchase of goods to fulfill orders.
Conclusion
Purchase order financing can be a lifeline for your business particularly if you’re struggling with cash flow challenges or have difficulty securing traditional financing.
By providing upfront funding to fulfill customer orders, it allows you to seize growth opportunities, meet customer demands, and maintain a healthy cash flow. But it is essential to approach purchase order financing with a clear understanding of its costs, terms, and potential impact on profitability. Careful evaluation and consideration of the specific needs and circumstances of the business are crucial.
Taking proactive action to explore purchase order financing can help unlock growth opportunities, improve customer satisfaction, and ensure a steady path towards business success.
If you’re looking for the perfect purchase order financing partner, look no further. Bridger’s the one for you. Use Bridger today