Business Loans
Meredith Wood
Updated on October 19, 2020
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What Is Purchase Order Financing?
Purchase order financing is a funding solution for businesses that lack the cash flow to buy the inventory needed to complete customer orders. The purchase order financing company will pay your supplier to manufacture and deliver the goods to the customer. The customer then pays the purchase order financing company directly, who then deducts their fees before sending the remainder to you.
For new businesses that receive several orders at once and don’t yet have the cash flow to purchase the necessary inventory, purchase order financing (also called PO financing or PO lending) can be a simple solution to ensure you don’t have to turn the customer away.
In this guide, we walk through how purchase order financing works, the pros and cons, the cost, and how purchase order financing compares to other types ofbusiness loans.
- How Purchase Order Financing Works
- When to Use It
- Pros and Cons
- Alternatives
How Purchase Order Financing Works
The process of purchase order financing is simpler than it might sound. Before we jump into the steps of the process, let’s define a few terms:
- Borrower/seller: This is you, the person seeking advance funding or financing to fulfill a purchase order.
- Purchase order financing company/purchase order lender: This is the lender or the company that’s providing the financing.
- Supplier: This is the company that manufactures or distributes the goods.
- Customer: This is your customer, the party that’s trying to buy the goods and who has given you a written purchase order for the goods.
Step 1: You Receive a Purchase Order
Your customer submits a purchase order to you that specifies the type and volume of goods they’d like to purchase. Based on this information, you should be able to determine whether or not you’ll need to access financing to fulfill the order. If you do, this initiates the process of purchase order financing.
Step 2: Your Supplier Estimates Your Costs
You ask the supplier how much it will cost for the amount and type of goods requested by the customer. The supplier sends you an invoice for the costs. This is likely the point where you confirm you can’t afford to fulfill this order because you don’t have enough cash on hand to buy the supplies you need.
Step 3: You Apply for Purchase Order Financing
When you confirm you can’t afford to purchase the supplies necessary to fulfill your customer’s order, you can apply for purchase order financing. The lender will approve you for up to 100% of your supplier costs, depending on your qualification requirements, your customer’s creditworthiness, and your supplier’s reputation. It’s more realistic to get approved for 80% or 90% financing.
Step 4: Your Supplier Gets Paid
The purchase order financing company pays your supplier. If you didn’t qualify for 100% purchase order financing, then you’ll have to make up any shortfall by paying the supplier the difference on your own. The supplier can now do the work necessary to fulfill your customer’s purchase order.
Step 5: Your Supplier Delivers the Goods to Your Customer
The supplier directly ships the goods to the customer. Be sure to note that you won’t be the middleman here as you might typically be if you weren’t using purchase order financing.
Step 6: You Invoice Your Customer
Once the supplier delivers the goods to the customer, they’ll let you know. Now, it’s time for you to invoice the customer for the goods.If the customer plans to pay over time, the lender may purchase the invoice from you at a discount. This would be considered invoice factoring or factor lending. This typically has lower fees but helps you to access your money faster.
Step 7: Your Customer Pays the Purchase Order Financing Company
When your customer pays their invoice, they will submit their money to the purchase order financing company directly—not to you. Yet again, you’ll be on the sidelines for this step of purchase order financing. Alsoremember that the faster your customer pays the lender back, the faster you’ll get your cut of the profits.
Step 8: The Purchase Order Financing Company Forwards Your Money
Once the purchase order finance company receives payment from your customer, they deduct their fees and forward you the remaining sum of the proceeds from the purchase order. Practically speaking, the purchase order financing fees will act like the interest on your financing.
When to Use Purchase Order Financing
Any business that needs to buy supplies to fill a customer order but can’t afford those supplies might benefit from purchase order financing. Companies that use purchase order financing include:
- Startups
- Business owners with low credit scores
- Wholesalers
- Distributors
- Resellers
- Importers or exportersof finished goods
- Outsourced manufacturers
- Government contractorswho are fulfilling government orders
One of the keys to knowing if your business qualifies for purchase order financing is whether you sell a completed product. If you sell services or materials, your business won’t qualify for purchase order financing.
Purchase order financing will help businesses who find themselves in these types of situations:
If your business has experienced any of these cash flow problems, purchase order financing might be able to help smooth the flow of your business.
Advantages and Disadvantages of Purchase Order Financing
Advantages
If you’re struggling to buy the supplies you need to fulfill an order or are facing acash flowproblem, purchase order financing might be just the solution. Here are some pros to consider.
Easy to Qualify
Purchase order financing is a good choice for business owners who are having a hard time getting approved for a loan or have a low credit score. Purchase order loans have fewer, less restrictive requirements for approval than do traditional bank loans. The purchase order sort of acts as collateral to back your loan.
In fact, purchase order lenders care more about your customers’ payment history and credit than they do about yours. Since your customer directly pays the lender after the goods are delivered, the lender wants to make sure your customer has a history of paying bills on time.
No Personal Guarantee
When you take on a regularbusiness loan, you typically have to sign apersonal guarantee. This means that if the business can’t pay back the loan, the lender can seize your personal assets to get their money back.
PO financing is typically non-recourse. This means if your customer is unable to pay for the goods, the lender absorbs the risk. You won’t be responsible in most cases. Whether the customer refuses the shipment of goods, is dissatisfied with the product, goes broke after the shipment, or for any other reason doesn’t pay, the lender loses their money.
Of course, you should check with the lender about their policies in the event the customer doesn’t pay.
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Startup owners often find themselves in a catch-22. They have a hard time getting funding because they don’t have a track record, but they are in rapidgrowth mode. If a startup turns down even one customer’s order, that can seriously hamper the company’s growth prospects. Purchase order financing helps you keep all your customers satisfied while shoring up your cash flow.
Flexible Funding
Purchase order financing technically isn’t a loan, even though you are borrowing money. When your cash flow dips, you can trade in outstanding purchase orders for funding. Plus, you can finance up to 100% of your costs in one lump sum without having to worry about paying back the money in installments.
PO financing is much more transaction-focused and flexible than, say, a bank loan orSBA loanthat you make a long-term commitment to paying back over several years in small installments.
Disadvantages
Just like any other form of business funding, purchase order financing isn’t necessarily for everyone. Be sure to consider the downsides that come with purchase order finance.
Fees Can Be High
Purchase order financing is certainly not the most expensive type of business funding. It’s more affordable than, for instance, short-term loans and merchant cash advances. But the fees of PO lending can add up over time. Providers charge around 1.8% to 6% every month. When converted to an annual percentage rate (APR), PO financing can run in the range of 20% to 75%. This is much more expensive than a bank loan or SBA loan.
100% Financing Isn't Guaranteed
With purchase order financing, you can get up to 100% financing for your supplier costs, but more realistically, you’ll get only 80% to 90% upfront. Since there’s a chance that your customer might not pay the bill, the PO lender usually lends you only some of the costs. You’ll get the rest (minus the lender’s fees) when your customer pays for the goods, but this means you still need to initially come up with some cash yourself to complete your customer’s order.
Not Available for Service Businesses
To qualify for purchase order financing, you need to have physical goods that the supplier can manufacture and deliver to your customer. PO financing is not available for businesses that sell services. If you offer services and invoice your customers for them, theninvoice financingmight be the better option for you.
Short-Term Funding Only
Keep in mind that purchase order financing is designed for businesses that need fast, short-term access to cash. In most cases, customers pay for the goods within one to two months, and the financing tides you over during that time period. But if you have larger business costs that you’d like to finance, such as launching a new product or opening a new location, then you’ll want to look into getting a traditionalterm loan.
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How to Qualify for Purchase Order Financing
Purchase order financing is fortunately pretty simple to qualify for.
Here are the typical qualification requirements for purchase order financing:
- Sell finished goods, not raw materials or product parts
- Sell to B2B or B2G customers
- An order of at least $20,000
- Profit margins of at least 15% to 20% (calculated per transaction by comparing your supplier’s costs to the amount you charge your customer)
- Sell to creditworthy customers
- Have reputable suppliers who can manufacture and deliver the goods to your customer on time
One of the key things to remember with purchase order financing is that the lender isn’t as interested in your credit history as they are in your customer’s credit history and supplier’s reputation.
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Finding a Purchase Order Financing Company
There are several types of companies that you can work with if you’re in need of purchase order financing—microlendersand online companies both offer this type of financing—but it can be hard to know which are reputable.
Here are some questions you might ask when considering a purchase order financing company:
- How many transactions have you handled in my industry?
- How long have you been in the purchase order financing business?
- What other types of loan products do you offer?
- Do you have a team of specialists who work only on purchase order financing?
- How do you advance funds?
- Do you pay my suppliers directly? When?
- What will be my costs of purchase order financing?
- What’s the APR on this financing?
- What kind of background or credit check do you run on my business, my customers, and my suppliers?
- How do I or you receive payment from my customers?
- What happens if my customers don’t pay on time or refuse delivery of the goods?
- Do you communicate at all with my customers?
Purchase Order Financing Alternatives
Purchase order financing has many advantages, but it’s not for every type of business. Here’s purchase order financing compared to other types of business financing.
Purchase Order Financing vs. Invoice Financing
A common misconception is that purchase order financing andinvoice financing/invoice factoringare the same thing. But, there are key differences.
Factoring is a loan based on invoices you’ve already sent to your customers. In this scenario, you already paid for the goods and are waiting for the customer to pay. Purchase order financing is based on an order that you haven’t yet delivered or invoiced the customer for.
The other difference is when you see the money. If you use invoice factoring, you will receive the funds from the lender. But with purchase order financing, the lender sends the funds directly to your supplier.
The final difference you should be aware of is the cost. The risk taken on by the lender is higher in purchase order financing (because your customer might refuse the goods or not be able to pay), so they charge higher interest rates. If you’re looking to save money, invoice factoring typically costs less money than purchase order financing.
Purchase Order Financing vs. Short-Term Loans
Short-term loans and purchase order finance have a lot of similarities. They both can cover temporary gaps in cash flow, the cost is similar, and both are relatively easy to qualify for. However, short-term loans and PO financing are structured very differently.
Ashort-term loanis an installment loan, meaning you borrow money from a lender and then pay back the money over three to 18 months, in weekly or daily installments. The lender gives you the funds directly and you can then use them to pay for whatever business expenses you need to cover: working capital, paying staff, paying for marketing, or for other business activities.
Purchase Order Financing vs. Business Credit Cards
If your primary reason for using purchase order financing is to cover temporary gaps in cash flow, consider using abusiness credit card. You can use a business credit card to borrow small amounts of money when you can’t afford to buy supplies for an order. And then you can pay off the amount you borrowed when your customer pays for the goods.
Many are surprised to learn that business credit cards are actually a relatively affordable type of financing. The average APR on a business credit card is around 14%, compared to the 20% to 75% APR range on purchase order financing. The drawback to business credit cards is that your credit limit might not be high enough to purchase supplies for several orders (or even for one large order).
An especially useful type of credit card to fund larger purchases is a 0% introductory APR credit card. For the length of the introductory period (up to 12 months), you won’t pay interest on your balance. Just be sure you have a plan to pay it off before the intro offer ends and a variable APR sets in.
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Frequently Asked Questions
The Bottom Line
Purchase order financing is a great way for growing businesses, seasonal businesses, and temporarily cash-strapped businesses to receive advance funding. But make sure you understand all the pros and cons and alternative types of funding.
No matter why your business needs purchase order finance, we hope this guide helped you to better understand the ins and outs of this type of funding so you can decide if it’s the right solution for your business.
Vice President and Founding Editor at Fundera
Meredith Wood
Meredith Wood is the founding editor of the Fundera Ledger and a vice president at Fundera. She launched the Fundera Ledger in 2014 and has specialized in financial advice for small business owners for almost a decade. Meredith is frequently sought out for her expertise in small business lending. She is a monthly columnist for AllBusiness, and her advice has appeared in the SBA, SCORE, Yahoo, Amex OPEN Forum, Fox Business, American Banker, Small Business Trends, MyCorporation, Small Biz Daily, StartupNation, and more. Email: meredith@fundera.com.
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FAQs
How does purchase order financing work? ›
Purchase order financing is a cash advance that small-business owners can receive on their purchase orders. With PO financing, a lender will pay your third-party supplier up to 100% of the costs required to produce and deliver the agreed-upon goods to your customer.
What documents are required for purchase order financing? ›- Customer's purchase order.
- Your supplier's invoice to you.
- Your invoice to the customer.
- Financial statements: profit and loss statements, balance sheets, and cash flow statements.
- Tax filings.
Advantages of PO Financing
Because they're paying the supplier directly, you don't have to deal with being the middleman in the transaction process. All you do is fill out the convenient application. You'll find out if you're approved fast, and funds typically make it to the supplier within 24 hours.
Those who buy your goods ultimately pay the PO financing company. Factoring occurs when a business receives an advance from a factoring company for unpaid invoices from another business or government entity for goods already produced or sold. The factoring company then receives payment from those that you invoiced.
How does a PO process work? ›A purchase order (PO) is an official document a buyer sends to a seller. The purchase order binds the buyer to a promise to pay the seller for designated products at a future date. The purchase order form itself specifies the types and quantities of each product. Purchase orders are beneficial to both parties involved.
What comes first purchase order or invoice? ›A purchase order is created before the goods or services are delivered. On the other hand, an invoice is created after the goods or services have been rendered.
What is PO funding? ›Purchase order finance, also known as 'PO Finance', provides funding for businesses with purchase orders to pay their suppliers and smooth out cash flow. Purchase order financing is, therefore, an effective and popular option for those businesses which need a quick and effective way to finance their purchase orders.
Can I get a loan with purchase order? ›Yes, you can finance up to 100% of the purchase order costs. Rates will typically fall between 1.8% and 6% per month. Purchase order financing will take 1-2 weeks to fund. If you're looking for a quicker solution, you'll need to consider a short term business loan.
Can purchase order be used as collateral? ›Purchase orders may not be seen as collateral assets to support the financing PO application. The requirements of conventional lenders are usually strict and onerous. One of the many conditions is about the size of the purchase order to be significant.
What is invoice collateral? ›Invoice financing is a form of short-term borrowing in which your business borrows money against the amount due on invoices you've issued to your customers. These trade receivables are then used as collateral.
What is on invoice discount? ›
Invoice discounting is the practice of using a company's unpaid accounts receivable as collateral for a loan, which is issued by a finance company.
What are the disadvantages of PO? ›The drawbacks of using POs include:
POs create additional paperwork, which can be annoying for smaller purchases and time-consuming for smaller teams. Although they don't act as a legal contract between the vendor and the supplier, credit cards can replace POs to help with record keeping and documenting purchases.
Purchase orders can act as a legally enforceable contract. Having a written agreement regarding the prices and quantity of items in your order protects both you and the seller. Purchase orders protect you by giving you a legal, binding record of exactly what you ordered and at what price.
What does it mean to finance a purchase? ›When you finance a purchase, you borrow money and pay it back with interest. Usually, you repay it in monthly installments. Before the lender gives you the money, you sign a contract outlining how much you are borrowing, the interest rate, how much your monthly payments will be, and when the loan will be paid in full.
What are the five major steps in the purchasing process? ›- Stage 1: Problem Recognition.
- Stage 2: Information Gathering.
- Stage 3: Evaluating Solutions.
- Stage 4: Purchase Phase.
- Stage 5: The Post-Purchase Phase.
Pertinent details, including supplier name, purchase quantity and cost of purchase, are matched across three related documents: a purchase order, delivery receipt and supplier invoice.
What is the key for purchase order? ›Invoices typically reference the purchase order number, with the addition of an invoice number to confirm that both documents are related and correspond with one another. A key difference is the order details and other technical information included in the purchase order generally are not included on the invoice.
How many types of PO are there in accounts payable? ›The four types of purchase orders are:
Standard Purchase Orders (PO) Planned Purchase Orders (PPO) Blanket Purchase Orders (BPO) (Also referred to as a “Standing Order”) Contract Purchase Orders (CPO)
...
Key differences between purchase order and invoice.
| Purchase Order | Invoice |
|---|---|
| Makes it easy to track inventory | Helps compute spend and taxes |
Yes, you can finance up to 100% of the purchase order costs. Rates will typically fall between 1.8% and 6% per month. Purchase order financing will take 1-2 weeks to fund. If you're looking for a quicker solution, you'll need to consider a short term business loan.
What is a purchase finance charge? ›
A purchase finance charge is a fee applied to purchases on a credit account like a credit card. This typically takes the form of an interest charge, although some accounts may have other terms.
Can purchase order be used as collateral? ›Purchase orders may not be seen as collateral assets to support the financing PO application. The requirements of conventional lenders are usually strict and onerous. One of the many conditions is about the size of the purchase order to be significant.
How does supply chain finance work? ›Supply chain finance, also known as supplier finance or reverse factoring, is a set of solutions that optimizes cash flow by allowing businesses to lengthen their payment terms to their suppliers while providing the option for their large and SME suppliers to get paid early.
What is PO required on a credit application? ›Purchase order financing allows businesses to fulfill orders before they've invoiced and received payment for those orders. Essentially, it's an advance against the money you expect to receive once customer invoices are paid.
What is a purchase loan? ›A purchase money loan is issued to the buyer of a home by the seller. It is also called seller financing or owner financing. Purchase money loans are often used by buyers who have trouble getting a traditional mortgage due to poor credit.
What is a financial invoice? ›Invoice finance definition
Invoice financing is a form of short-term borrowing in which your business borrows money against the amount due on invoices you've issued to your customers. These trade receivables are then used as collateral.
A common way of calculating a finance charge on a credit card is to multiply the average daily balance by the annual percentage rate (APR) and the days in your billing cycle. The product is then divided by 365 . Mortgages also carry finance charges.
What 3 factors determine the amount you pay in finance charges? ›What three factors determine the amount you pay in finance charges. interest rate charged , amount of credit used, and length of the repayment period.
What is the minimum finance charge? ›A minimum finance charge is a monthly credit card fee that a consumer may be charged if the accrued balance on the card is so low that an interest charge under the minimum would otherwise be owed for that billing cycle. Most credit cards have a minimum finance charge of $1.
What is a capital purchase order? ›A CAPEX Purchase Order is a purchase order used for Capital Expenditures (CAPEX). Capital purchases include property, plants, buildings, technology, and equipment.
What is local purchase order? ›
In Accounting, LPO means Local Purchase Order, document issued by a buyer to a seller, indicating the products, quantities and agreed prices for products or services that the seller will provide to the buyer within the national or local boundaries.
What is Vendor capital? ›Vendor Capital Contribution means the contribution by the Vendor of the outstanding shareholder loan owing by Homestake to the Vendor to the capital of Homestake as a capital contribution to the Homestake Shares, such that the shareholder loan will be eliminated as of Closing.
What is the difference between factoring and supply chain finance? ›Supply chain financing vs. factoring: What's the difference? Unlike factoring, where a supplier sells its receivables at a discount to a third party (a factor) for early payment, supply chain finance is a financing solution initiated by the buyer where the buyer agrees to pay an invoice early for a discount.
What are different types of supply chain finance? ›Supply Chain Finance is a segment of Trade Finance. Supply Chain Financing is a set of services available for Medium-Sized and Big Corporates. For example, Loans, Purchasing Order Finance, Factoring and Invoice Discounting are the most common.
What is the difference between supply chain finance and trade finance? ›While both trade finance and supply chain finance are designed to finance international and domestic supply chains, trade finance offers a broader set of solutions.