Purchase order financing, also known as PO Financing is a short-term financing method that businesses can use to cover the cost of manufacturing or purchasing goods that have been presold to clients via a purchase order.
For example, a company has a sales order for a customer for goods they don’t currently have in inventory. To fulfill the order, to fulfill their commitment with the customer, the company will need to manufacture the products and/or purchase the goods from a supplier, but the company lacks the liquidity to purchase the goods.
Purchase Order Finance is a viable solution in the above example since a purchase order financing companies advance payments to suppliers directly to fulfill the client’s order. Once the company delivers the goods to its client, the company will raise a receivable invoice to the final buyer and request the buyer to settle payment directly with the finance company. The financing company will calculate all financing charges and pay the remaining amount to the borrower.
Purchase order financing costs
Purchase order financing can be costly, with fees typically ranging from 1.8% to 6% of the purchase order value per month. Part of the reason why PO financing costs are typically high is due to the risk factors associated with the transaction such as performance risk, dilution risk and risk of contractual defaults and at times buyer/manufacturer insolvencies.
How does purchase order financing work?
One of the ways purchase order financings differ from a normal business loan is that there are more parties involved. A business loan involves only the lender and you as the borrower. But with purchase order financing, there are four parties involved: your business, the purchase order financing company, your customer and the supplier.
Here’s an overview of how the process typically works:
When a business receives an order from a customer, they may not have the cash or inventory on hand to fulfill it.
A business should be aware of how much working capital is available to fulfill their purchase/sale commitments. If the business lacks capital, then it will apply for purchase order financing to fulfill the purchase order. The business must submit an application to the purchase order financing company. The financing company will conduct a credit assessment and due diligence on the applicant, if clients meet the credit criteria, the application is typically approved. A typical purchase order finance only covers up to 80% of the supplier’s costs, depending on your supplier’s track reputation and the customer’s creditworthiness. The financing company approves the client for only a percentage of the purchase order, the client is required to pay the remaining balance.
Once the client’s application is approved, the purchase order financing company pays the supplier to manufacture and deliver the goods and, in some cases, the financier can also pay the manufacturers directly for the goods produced.
Once goods are delivered, the client can raise a receivable invoice to its customer and would typically copy the finance company. The company will instruct their customer to make payments directly to the financing company.
The financing company will issue a payment request to the borrower disclosing all the fees and settlement amounts. All remaining balance after fees are settled should be transferred to the company.
Purchase Order Financing, also known as PO Financing, is a type of funding solution that a business can use to pay suppliers for the goods needed to fulfill specific purchase orders. This kind of financing is a great solution for businesses in a variety of industries, both domestic and internationally. Financing companies have the capabilities of arranging funding of client’s purchase orders directly to manufacturers, wholesalers, distributors.