82 percent of small businesses that fail attribute their downfall to cash flow problems.
Doing business is tough. You are attempting to please your customers, maintain good relationships with your suppliers and all the while operating in a very competitive space.
Needless to say, the stars do not always align and, more often than not, small business owners find themselves short of cash.
When this happens, you stand to lose your customers, and subsequently, your venture. Today, fortunately, there are some financing options that can keep you afloat during such trying moments.
If you find yourself in a situation where you are unable to fulfill a customer’s order, you might want to consider getting purchase order financing. This article is a guide to everything you need to know about purchase order financing.
What Is Purchase Order Financing?
Commonly abbreviated as P.O. Financing, it refers to an advance that a financial institution gives you so that you can obtain goods from your suppliers and sell them to a customer who has already completed a written purchase order.
As such, this financial tool helps businesses that need money to fulfill their product orders by making an upfront payment to their supplier for the goods needed.
However, unlike inventory line of credit financing which allows you flexibility in terms of what inventory you can buy, P.O financing can only be used for the purchase of the specific goods required to meet a client’s order.
For a business to be eligible for P.O. Financing, it must be involved in the selling of finished products – not raw materials – to B2G or B2B customers who have profit margins of 15 percent plus.
Young businesses such as startups can also qualify, as your viability is largely dependent on your creditworthiness as well as your history with customers and suppliers.
It is, therefore, quite easy to qualify if you have a good credit record and your business partners (suppliers and customers) are established and reputable businesses as well.
The main benefit of using PO financing is that it allows you to grow your business without having to sell your equity or take a bank loan.
And if your sales are outpacing your income flow, you should definitely use this tool to meet customer demands.
PO financing is funding you get before you deliver and before you invoice your customer. If you have already delivered and you need cash to keep your business afloat, then you should look at, not PO.
Who Can Use PO Financing and When?
There are various situations where you will find PO financing to be the most appropriate financial tool at that moment. Such situations include:
• Seasonal Sale Spike
During the initial days of seasonal sales, businesses often find themselves receiving purchase orders that exceed their working capital.
• Substantial Growth
There are times that a business’s sales growth might start outpacing their lines of credit due to overall growth. In such instances, you should consider purchase order financing.
• Tight Cash Flow
Due to various reasons, a business might be experiencing cash flow problems. If this happens consistently, then having the back up of PO financing should ensure that you keep your affairs in order.
Nevertheless, the above are just some of the likely and most common scenarios where you might need PO financing. There are many other situations where this tool can come in handy.
How PO Financing Works
A minimum of four parties needs to be involved in order for you to get your funds. They include:
- The borrower: This is the party seeking to get funds to enable their operation.
- The financing company: This is the party providing the funds necessary to fulfill their customer’s needs.
- The supplier: The party who gets the funds so they can release the goods to the borrower.
- The customer: The party who has requested for good from the borrower.
Seeing that there are many moving components required to work harmoniously so that the borrower can get what they need, any of them can make the process difficult.
For example, if the suppliers take too long to release the goods to you, you might have to start paying extra. This is because the longer you take to pay your financing company, the costlier the loan gets.
As such, it is vital that you are on the same page with your suppliers and customers before you request for financing.
Steps Involved in Purchase Order Financing
There are eight steps involved in purchase order financing. Of course, it isn’t like a flowchart process but one thing usually precedes the other.
The business gets a large purchasing order from a customer.
The borrower requests for a written proposal from the supplier on the costs involved in purchasing the products necessary to meet their customer’s demands.
If upon receiving the proposal the borrower discovers that they do not have the funding necessary to fulfill the customer’s order, they embark on seeking outside financing.
The borrowing business finds a reputable purchase order financing company and applies for funding. To be eligible for application, your business needs to provide the customer’s purchase order as well as the supplier’s proposal.
If the borrower’s application is approved, the purchase order financing company sends cash to the supplier – usually through a letter of credit. These funds allow the supplier to process the products needed to meet the purchase order.
The supplier will then proceed to either deliver the goods directly to the customer or send them to the borrower. This will depend on what the parties involved agree upon. Upon receiving the goods, the customer must indicate that they have done so.
The business sends an invoice to the customer for the goods and can either demand immediate payment or give them new terms. However, the faster, the better since, the longer the customer takes to pay, the costlier the financing becomes.
The purchasing order financing company receives direct payment from the customer for the full price indicated on the invoice.
The financing institution deducts its fees from the customer’s payment and sends the balance to the borrowing business.
Benefits of PO Financing
There are several advantages to obtaining funds through purchase order financing. Some of them include:
1. Easy to Qualify
PO financing offers a way out for businesses that have a low credit score or are struggling to get their loans approved.
This is because a PO financier is only interested in seeing an authentic purchase order. It serves as collateral and thus, all the other requirements that other lending institutions typically have do not have weight here.
In fact, a PO financier is usually more concerned about your customer’s ability to pay than yours. As mentioned earlier, the customer pays the financier directly.
2. No Personal Guarantee
With other financing options such as bank loans, you normally have to sign a personal guarantee.
A personal guarantee is a statement from you indicating that if your business is unable to pay back the loan, your personal assets can be seized by the lender so they can get their money back.
PO financing, however, is usually non-recourse. The implication is that if your customer does not pay for the goods delivered to them, the financial institution will absorb the risk.
The borrower is, for most cases, not responsible if such a scenario were to occur. The same goes if the customer refuses the goods.
Nonetheless, it is necessary to check with your lender to see their policies regarding default by the customer.
3. Startups Can Benefit Immensely
The early stages of a startup are usually the hardest to navigate. This is because even though the business might be in a rapid growth mode, it might still have difficulty obtaining funding due to a lack of a track record.
What to Look For in a PO Financing Company
Just as with any other money-lending institutions, different PO financing companies have different policies.
Thus, before you get into an engagement with one, it is vital that you read the fine print so you know what you are getting yourself into.
Nonetheless, to help you get the best fit for your needs, ask your potential provider the following questions:
• How long they have been in business
• How many transactions similar to yours they have handled
• Their costs in addition to a breakdown of those costs
• How the funds are transferred between them, the supplier, the customer, and the borrowing business
The answers to these questions will allow you to gauge the level of transparency the company has. A reputable company typically has straightforward processes.
Is PO Financing the Right Option for You?
Many startups and small businesses that do everything right from the beginning tend to experience fast growth. The catch 22, however, is that they may soon start getting more orders than they can afford to finance.
If you are in a situation where your problem is finding financing to service your customer’s order, then purchase order financing might be the right financial tool for you.
Are you looking for financing for your small business?
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