Commonly referred to as ‘PO Finance’, Purchase Order Financing is a financing method for businesses that allows them to source funds for large orders even when they don’t have the cash flow required. Basically, the company in question can acquire cash for goods that have been ordered but not delivered yet. It is almost similar to invoice factoring, only in this case, instead of selling the invoice, the company just sells the purchase order. After that, once the goods have been delivered to the client, they pay the PO Financing company who then deducts their share and sends the rest to the selling company.
Who Is It Most Suited For?
Purchase order financing is mostly suited to companies who have credit-worthy clients and a large number of orders to fulfill but don’t have enough capital. It is therefore an easy source of working capital to help companies that may have incurred a shortage in cash flow. Start-ups and companies that experience seasonal peaks might be the ones to benefit most from purchase order financing as they tend to have highly unpredictable cash flows. Government contracts, wholesale distributors, industrial, manufacturing, importers, exporters, drop-ship orders, and direct ship orders are some of the types of businesses usually benefit most from this.
Guidelines For Eligibility
PO financing companies don’t just buy purchase orders from any company. With the high amount of risk involved, they need to be very selective with who they work with, otherwise, they might run into a string of defaulters who’ll just drown the company. For this reason, there are a few eligibility guidelines that the financing companies usually put in place. They might vary from company to company but all tend to have a similar baseline. Some of the most common eligibility guidelines are listed below.
- The minimum gross profit for transactions must be at least 20%.
- The company should have worked with and conducted similar business with comparable clients.
- Recurring transaction of at least $50,000.
- You must provide qualified purchase orders or letters of credit.
- Only applies to finished goods, not those that are yet to be manufactured.
The Process of Purchase Order Financing
PO financing is usually structured in different ways and the process by which the involved parties go about it is mostly dependent on the PO financing company as well as industry and location of the buyers as well as the timing of the transaction.
Typically, once the order is received and the financing company has verified everything they need to and confirmed that you are eligible, they will issue a letter of credit to the reseller’s supplier or pay for the order directly. The supplier will then ship the goods to the client just as required. Once they’ve been delivered, the client will pay for them as agreed with the supplier but payment will be to the purchase order financing company. The financier will subtract its fees and send the rest back to the reseller.
Purchase order financing is a very reliable mode of financing operations but is only ideal for companies or businesses that have credit-worthy clients.