Purchase Order Financing: Companies, Rates & Terms
What Is Purchase Order Financing?
It’s not uncommon for a small business to be low on the funds it needs to fulfill a large order, but find their credit score is too low to qualify for a traditional financing solution. So, what can they do? The answer may be purchase order financing.
Purchase order financing helps to fill a working capital gap on larger orders using a purchase order from a customer as collateral. Since the credit decisions of Purchase Order Financing Companies are based on the creditworthiness of the customer, rather than the small business, they are much easier to qualify for than traditional methods. Although you do need to be aware that it often takes time to receive funds through Purchase Order Financing, usually around 1 to 2 weeks.
Who Qualifies For PO Financing?
Purchase Order Financing is designed for small businesses that need to deliver large orders for their business to grow. This can mean they are more vulnerable to cash flow issues as they fulfill the large orders.
The business types that usually qualify for PO Financing include:
- Businesses with very seasonal sales structures
How Does Purchase Order Financing Work?
If your business is unable to afford to supply and/or deliver an order to a customer, Purchase Order Financing can work to finance a full order, or part of an order, to allow operations to run smoothly, even with little cash flow.
To start, your customer will submit a purchase order, and you will then find out from your supplier how much it will cost you, and send you an invoice. This is when you will be able to decide whether you will need to use PO Financing to complete the order or not. If that is the case, you partner with a Purchase Order Financing Company.
This company may approve you for around 80-90% financing, although it can be as much as the full 100% of the purchase order. They will take into account whether your business meets their requirements, the reputation of your supplier, and the creditworthiness of your customer.
Your PO Financing Company will then pay your supplier. If they did not agree to pay the full amount, you will have to make up the rest from your business’ finances. Once the supplier has been paid, they will get to work on the order.
When the order is ready, it will be delivered to your customer by the supplier, then you can invoice your customer. This invoice will be paid by the customer directly to the Purchase Order Financing Company. The financing company will then take their fees from the invoice amount and send the remaining amount to you. It is these fees that are essentially the interest rate of the financing.
What Are Purchase Order Financing Rates?
The majority of Purchase Order Financing Companies will base their rates on utilized funds, which are the outstanding funds of those that were used to give payment to your supplier.
Purchase Order Financing Rates tend to average 3% for every 30 days based on those utilized funds. However, this can vary depending on the individual purchase order amount and how complex the transaction is likely to be. You will also have better rates if you are working with a supplier with a good reputation, and the same goes for your customer.
If it is a particularly large order that is being dealt with, many Purchase Order Financing Companies will use a tiered structure that allows for several payments, for one order, to be spread out over a period of time. This is beneficial to you as it will cost you less than if it had been fulfilled in one go.
Although every PO Financing Company is likely to structure their rates differently, you can expect one of the following purchase order financing examples:
- 3% for the first 30 days and 1% per 10 days after that
- 3% for the first 30 days and 0.1% per day after that
- 2% for the first 20 days and 1% per 10 days after that
It should also be noted that some Purchase Order Financing Companies have a minimum transaction amount that they will finance, but this varies depending on the individual company.
How Much Does Purchase Order Financing Cost?
The cost of PO Financing is different for every transaction. As outlined above, the monthly percentage rate is based on the terms of the lender, including upfront payment, delivery as outlined by a contract, and how long you may have to wait between goods being delivered and when the invoice gets paid back to you (which can be anywhere from 60 to 90 days).
Many small businesses think it is well worth giving a percentage of their profits to a Purchase Order Financing Company if it means making a sale large enough to support an entire year of business. But this might not be the case for your business, so you need to think carefully about the pros and cons of using Purchase Order Factoring.
How To Get Purchase Order Financing
PO Financing loans have fewer requirements than traditional financing options as the purchase order itself basically acts as collateral, this is also beneficial as you won’t need a personal guarantee.
Purchase Order Financing Terms will also vary depending on the lender, but you will typically need to meet these requirements in order to be approved for PO Financing:
- You must only sell complete products – you cannot sell raw materials or only parts of products
- You must sell to business-to-business or business-to-government customers
- Your purchase order is at least $20,000
- Your business must have profit margins of 15-20% per transaction
- You must sell to creditworthy customers
- You need to have suppliers with a good reputation who will be able to manufacture and make on-time deliveries to your customers
Once you have found a PO Financing Company you would like to work with, you will typically have to supply them with the following documents:
- The order information
- The invoice from your supplier
- The invoice to your customer
- Your purchase order to the supplier
- Your business information
- Any legal information
- Financial statements
- Tax filings
Are There Alternatives to Purchase Order Factoring?
If you think that Purchase Order Factoring is not the right way for your business to get financial help, there are several alternatives.
Business Line of Credit
A Business Line of Credit can be used to cover expenses within a small business, and you only have to pay interest on the cash that you actually use, even if the line of credit is for a large amount. This allows you more flexibility than most other financial options, and it is more cost-effective, as once you have repaid the borrowed money, you can use it over and over again. While some lenders will require you to have a good credit score, it is also possible to get a business line of credit with low credit, use it to build up your credit, so this could be a good alternative to purchase order factoring.
Short Term Loans
Short Term Loans can also be used to finance unexpected gaps in cash flow, to be used for working capital, to pay your staff, marketing, and emergency expenses, to name a few. A Short-Term Loan allows a business to borrow a relatively small amount from a lender, to cover the needed costs, and then they pay the money back in daily or weekly installments over 3 to 18 months. These loans have the advantage that they are easy to apply and qualify for, they have a fixed repayment structure, and you can get funding in as little as one day. Unlike PO Financing, you will, however, need to meet the minimum credit score requirements of the lender.
Another alternative to PO Factoring is SBA Loans, which are particularly low-cost loans that can provide large sums of money. SBA Loans come with interest rates ranging from 4.99%, although this will vary depending on the lender and how much money you want to borrow. SBA Loans can be used for working capital, to refinance existing debts, to purchase equipment, or to buy real estate.
The downside to these loans, however, is that they are much more difficult to qualify for, you will need to have a good credit score of at least 680 and have been in business for at least 2 years in order to get one.