Glossary

Purchase Order Financing

Purchase order financing

If you’re a business owner, chances are you’ve had some teething problems while on your growth trajectory. Whether that’s a lack of funding or cash flow problems – it can be frustrating and stressful trying to secure funding and keep cash freely flowing.

Luckily, for those battling with cash flow, help is at hand. If you’re a business struggling to stump up the cash to complete an order, consider purchase order financing.

What is purchase order financing for small businesses?

Purchase order financing (or PO financing) is a term often floated around by businesses. But what does it mean?

Essentially, PO financing is a funding solution for businesses that lack cash flow. As the name suggests, it’s a type of finance that can be secured when you receive a purchase order.

How purchase order financing works is relatively simple. If you receive an order that you lack the funds or cash flow to complete, the financing company will pay your supply chain for you so you can fulfil your contractual obligations to customers.  

Your customer will then pay the purchase order finance lender, which will take a cut and send you on your way with the remaining cash.

When should you use purchase order financing?

Purchase order financing is typically for small businesses that need a quick release of cash to fulfil orders and pay suppliers.

There are many reasons why you may struggle with cash flow. Maybe your rent has eaten into your profits? Perhaps you’ve used up your cash reserves? Or maybe you’ve had problems with invoicing and customers paying on time?

No matter the reason for cash flow problems – PO financing is a quick and effective way to complete purchase orders and keep your customers happy.

Who can use purchase order financing?

If you’re a business that has to buy supplies to fulfil a customer order, you may be eligible for purchase order financing.

Purchase order financing is generally available to the following businesses:

  • Businesses with low credit scores or no track record (i.e. those who cannot get traditional loans)
  • Wholesalers
  • Distributors
  • Start-up businesses with little in the way of cash reserves
  • Resellers
  • Government contractors
  • Your credit score
  • Your customer’s credit score
  • The reputation of your supplier

In reality, lots of businesses are eligible to use purchase order financing. However, there is one caveat: if you sell services or materials then you won’t be eligible for PO financing in the UK.

However, if you sell a completed product, you’re good to go.

Why might I need to use PO financing?

Although in an ideal world you’d have enough cash to fulfil an order, it doesn’t always work out that way (especially for small businesses!).

Yet not having cash flow is not necessarily a terrible thing or an indicator that your business is doing badly. In fact, the opposite may be true. If you’re growing faster than the money is coming in, you may run into cash flow problems.

Your business may also be seasonal. For example, if you tend to experience a lull in the summer months but a boom in winter, PO financing is a great way to bridge the gap when cash flow is tight.

The same goes for cyclical businesses that tend to experience a drop if the economy drops - much like car manufacturers.

How does purchase order financing work?

If you’re considering purchase order financing, there are a few different steps to follow.

  • 1.Receive your purchase order
  • 2.Ask your supplier to estimate the cost
  • 3.Apply for PO financing
  • 4.Supplier delivery
  • 5.Invoicing
  • 6.Your customer pays the PO financing company
  • 7.The PO financing company will pay you what you’re owed

A seemingly obvious step, but you cannot use purchase order financing without a purchase order. The customer will need to specify the type and volume of goods they wish to purchase.

You can then decide whether you need to consider alternative financing methods.

Once you know the volume and type of goods your customer wants to order, you can ask your supplier for an estimate. That way you’ll know whether you can afford to fulfil the order. If you can’t, you’ll need another way to pay for it.

If you can’t afford to fulfil the order, you can apply for PO financing. Following your application, your purchase order financing lender will approve your business for either the full amount of supplier costs or a portion of it.

How likely you are to be approved and for how much depends on:

Once the supplier has been paid by the PO financing company, your supplier will deliver the goods directly to the customer. You won’t act as a middleman.

Once your customer has received the goods, they should notify you. You can then invoice the customer for their order.

Rather than paying you directly, your customer will pay their invoice to the PO financing company. As soon as they have paid, you will be entitled to your cut of the profits.

After deducting their fees, the purchase order financing company will pay you the remaining cash left from the invoice.

And that’s it. 

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    What are the advantages of purchase order financing?

    Although not suitable for all businesses, PO financing can be a lifeline when it comes to fulfilling larger orders for companies facing cash flow problems. Some of the benefits are:

    • It’s easier to be approved – Unlike traditional bank loans, purchase order loans have far fewer restrictions. That means they are often easier to secure and can offer a quick release of cash. This is the case even if you have a bad credit score, as the banks are more likely to be interested in your customer’s credit score than yours.  
    • They don’t require a personal guarantee Traditional loans often require you to sign a personal guarantee. This gives the bank the right to seize your assets if you cannot pay back the loan. With PO financing, the lender will absorb the risk. If for whatever reason your customer doesn’t pay, you won’t be personally liable.
    • They’re good for start-ups or growing businesses – If your business is expanding, there’s a good chance you’ll run into cash flow problems at some point. PO financing means you don’t have to turn down orders because of cash flow. If you are a small or growing business, purchase order financing doesn’t require a track record either.
    • It’s more flexible than a loan – With PO financing, rather than a typical loan that has to be paid back over several years, you can finance up to 100% of your costs in one go. This added flexibility is great for smaller businesses and start-ups.

    What are the disadvantages of purchase order financing?

    Although PO financing can be great for many businesses, it isn’t without its downfalls. Some potential disadvantages are:

    • It can be expensive – While PO financing is much more affordable than short-term loans and cash advances, the fees do add up over time. While PO financing rates vary, providers tend to charge between 1-6% each month, which can work out to be more expensive than bank loans in some cases.
    • You may not be able to cover the whole order – Although you can get up to 100% of the order value, it’s not guaranteed. Quite often you will be given between 80-90% of the order value upfront. So even with PO financing companies, you may still initially be short of cash.
    • It’s not available for all businesses – PO financing is not available for businesses that offer services. If you offer services to your customers, you’d need to consider invoice financing instead.
    • It’s only suitable for fulfilling orders – PO financing is designed for businesses that need a short-term cash injection. If you want cash to launch a new product or open a new site, traditional loans may be better suited.
    • It’s no secret – As your customer will pay the purchase order financing lenders directly, they’ll know you’re using PO financing. Although not inherently a problem, it’s a consideration to take into account. 

    How do you qualify for purchase order financing?

    Unlike typical loans, there are far fewer hoops to jump through for businesses. To qualify for PO financing all you need to do is:

    • Sell goods (as opposed to services, parts or raw materials)
    • Sell to customers with a good track record and credit score
    • Have reliable suppliers in place who will be able to fulfil the order
    • Have healthy profit margins and order values

    If you’re going down this route, you’ll also want to find the best purchase order financing company you can. It’s not always best to go for the cheapest.

    Is PO financing right for my business?

    Depending on your business, you may not be suited to PO financing. If this is the case, there are plenty more options you can consider.

    From invoice financing and factoring to short-term loans, business credit cards and cash advances – if PO financing isn’t a viable option for your business, all is not lost.

    If you’re wondering whether PO financing is right for you, contact our team today. They’re always on hand to talk through your situation and recommend the best options for your business.


    BY Jessica Lambert

    5 August, 2022

    4MIN

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