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Purchase order financing explained
Get the funds you need to fill orders when sales are greater than your incoming cash.
When your business is growing, sometimes its sales can get ahead of revenue. Purchase order (PO) financing is designed to help when your cash flow just doesn’t cut it — giving your business the funds it needs to fill customer orders. It’s not for every business, however. Your clients must be other businesses or government agencies — no individual consumers — and you can only use it to buy ready-made products from suppliers.
How does purchase order financing work?
Purchase order financing works by giving your business access up to 100% of the funds needed to buy products to fill customer orders. Instead of giving your business the funds, a PO finance company directly pays your supplier for the products and other fees like shipping. Your customers then pay back the PO financing company when it fills the invoice — usually within 30 to 90 days after receiving it.
How PO financing works in 8 steps
- A customer places an order, but your business doesn’t have the cash on hand to fill it.
- Your business asks its supplier for a written estimate of how much it would cost for you to fill the order.
- Apply and get approved for funds from a PO financing company for the amount you need.
- Your PO financing company directly pays your supplier or offers a letter of credit for up to 100% of the cost to fill your order.
- Your supplier fills your order, and your business sends it to the customer.
- Your business sends its customer an invoice.
- The customer pays your PO financing company.
- Your PO financing company gives your business the profits after subtracting a fee.
How could purchase order financing benefit my business?
Any business that relies on orders from other businesses and government organizations can benefit from PO financing. It can be particularly useful if your business experiences seasonal sales, is quickly growing or just doesn’t have a steady cash flow yet. Businesses in the wholesale, manufacturing, distribution, reselling and importing industries might want to take a closer look at it. Here are some reasons why your business might want to consider PO financing.
- You don’t need excellent credit. Rather than looking at your and your business’s credit, PO financing considers your customer’s and supplier’s creditworthiness instead.
- Startups may be able to qualify. While you won’t be able to use PO financing companies to cover startup costs, the fact that they care more about your customer’s history of repayment than your business’s makes it a viable option for new businesses.
- Helps your business grow or stay afloat. PO financing can help a growing business keep up the pace or maintain sales during the slow season.
- Doesn’t appear on your business’s balance sheet. Since PO financing doesn’t work like a traditional business loan, it won’t appear on your company’s balance sheet.
What will I need to qualify?
With PO financing, your business’s creditworthiness doesn’t matter as much as your supplier’s and your client’s. Here are some typical requirements you can expect from your lender.
- B2B or B2G business. Your company must have either other businesses (B2B) or government organizations (B2G) as its clients to be eligible for PO financing.
- Profit margin. PO financing companies usually require your business to make a minimum profit from the sale. Your business should sell its product for between 15% and 20% more than it costs to buy it from the supplier.
- Sell a physical product. If your business offers services rather than goods, it probably won’t qualify for PO financing.
- Work with creditworthy customers and suppliers. Generally, your clients and suppliers should have a history of making on-time payments and not have any past bankruptcies or other similar legal run-ins.
How much does PO financing cost?
Compared to other financing options, it’s not cheap. Typically, PO financing companies charge a percentage of the supplier costs, usually between 1.8% and 6% each month it takes for your clients to pay their invoices. Often, lenders charge one fee for the first 30 days and then another rate each additional day or every 10 days. Your clients usually have between 30 and 90 days to pay off their invoices, though the longer it takes the more expensive it gets.
For example, say your business qualified for R100,000 in PO financing with a fee of 5%. Generally, it’ll pay R5,000 for the first 30 days it takes your clients to fill their invoices. After that, you might pay an additional fee of 1% every 10 days or 0.1% per day. Let’s take a look at how this R100,000 PO financing loan works in different scenarios.
Cost example on R100,000 purchase order financing
|Days||Total cost at 1% every 10 days||Total cost at 0.1% per day|
As you can see, it can be less expensive to go with a lender that charges a percentage every 10 days, rather than every day. You might also come across PO financing providers that charge the initial fee for the first 20 days before charging a daily fee or every 10 days.
Why might I consider a different type of financing?
PO financing isn’t right for every type of business. Even if you can qualify, you might want to consider other financing options first. Here are some drawbacks to PO financing that might have you looking elsewhere.
- Can be expensive. If you have a good credit score, high annual revenue and have been around a few years, other cashflow fixes like business lines of credit may be cheaper.
- High profit margin required. Your profit margin may need to be 20% or higher to qualify for PO financing. That’s almost twice the average profit margin of businesses in 2017.
- Only for finished goods. You can’t use PO financing to cover other costs that might be associated with the sale, including installation or customization.
- Might not get 100% financing. Not all businesses can qualify for funds to cover 100% of the costs, leaving you to find money for the rest elsewhere.
- Your customer’s and supplier’s credit counts. As a business owner, you have less control over the creditworthiness of your customers and suppliers.
Alternatives to consider
Think PO financing might not be for your business? Curious about other options? You might want to look into these alternative cashflow fixes.
Invoice factoring is maybe the closest alternative to PO financing. It involves selling your company’s unpaid invoices to a third party for a percentage of the value up front, typically between 80% and 90%. Once your customers fill their invoices, your factoring company gives your business the remaining percentage with a fee subtracted — typically between 2% and 5%.
Invoice factoring fee structures work a lot like PO financing. Many charge one fee for the first 30 days and then a fee per day or every 10 days after you pay back your loan.
Similar to invoice factoring, invoice financing involves borrowing against your business’s unpaid invoices, which act as collateral. You’ll be able to use the funds how you see fit and can maintain a relationship with your customers. Generally, you can get up to 100% of your invoice’s value and pay it back as your customer pays you — typically over a maximum of three months. Costs typically include interest of 12% to 60% and a 1% to 5% servicing fee.
Short-term business loan
For one-time cashflow fixes, a short-term business loan might be a better solution, especially if your business has a hard time qualifying for a long-term business loan or line of credit. These come in smaller amounts than your standard business loan, typically between R2,000 and R250,000 — but you can get your funds in as little as one business day.
Business credit card
Business credit cards can provide another quick fix to expenses that are too small to be covered by PO financing. Once your business has a credit card in hand, you can get access to funds as fast as you can swipe. Getting that credit card can take a couple of weeks, so it works better as a preemptive measure.
This isn’t the cheapest option out there since rates typically run higher than business loans, often ranging from 14% to 25%. Some come with a 0% introductory rate, however, so for the first year your business can take more than a month to pay off its balance without gaining any interest.
Line of credit
Similar to a credit card, business lines of credit give you access to funds as you need them. Rather than applying for a fixed amount, your business qualifies for a credit limit, which it can draw from multiple times. Often, each withdrawal you make turns into a short-term loan with terms ranging from six months to a few years. Many are renewable, so your business can continually access funds.
A line of credit makes the most sense when your business has ongoing cashflow gaps and other recurring financing needs. Typically, rates range from 12% to 36%.
PO financing could be a useful resource for B2B and B2G businesses that have more orders than they can afford to finance. But the restrictions on what kinds of businesses and purchase orders can qualify means that it’s only really an option for a few key types. The high costs might also make you want to look elsewhere for funds, especially if your business has been around for a few years, makes more than R10,000 a month and you have good to excellent credit.
To learn more about your financing options check out our business loans guide. There, we break down how it all works and offer some options you can compare.
Frequently asked questions
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