English
As the name implies, PO financing is a type of cash advance that businesses get based on outstanding purchase orders.
It’s often a good solution for businesses that need to quickly fill large orders and are too short on cash to buy the necessary supplies.
Let’s put this in more concrete terms: Imagine you’re a small clothing company and suddenly a major retailer wants $200,000 worth of t-shirts in the next few weeks.
You don’t have nearly enough inventory on hand to fill the order or enough cash to stock up on fabrics and manufacture more.
And without much credit history, the bank doesn’t want to give you a loan. So what do you do? PO financing can be a solution.
To see how this would work, here’s a typical breakdown of what a transaction may look like for a business tapping PO financing:
1- Your company receives a large purchase order from a customer.
2- After reaching out to your supplier, you realise your business doesn’t have enough cash on hand to pay for all the supplies.
3- You find a third-party financing company that specialises in purchase order financing. After evaluating your application and verifying the purchase order (which acts as a type of collateral), they pay the supplier on your behalf.
4- After the customer receives the order, they pay the third-party financing company directly.
5-The third-party financing company deducts certain fees (more on that below) and then pays you the rest.
Read more about: Collateral Assessment: How Lenders Evaluate Loan Eligibility for SMEs?
- You don’t miss out on opportunities. Even though you will lose some of the profit margin to fees paid to the financing company, in return you will acquire a potentially huge new client or customer that can take your business to the next level.
- Even larger businesses face cash flow issues, and PO financing can be a stopgap solution during periods of low liquidity.
- The financing is not based solely on your company’s creditworthiness. The third-party financing company mostly cares about the creditworthiness of your customer, not your company, since they are the ones who will be paying them.
So, should you actually pursue PO financing? That depends largely on the cost.
Exorbitant fees could make it unprofitable.
Most third-party financing companies charge from 1.5% to 6% of the total purchase order value per month.
In other words, if you need $100,000 to fill an order and the fee is 3%, your company will pay $3,000 for the financing.
But there’s a major caveat. If the customer doesn’t pay within the first thirty days, you will likely have to keep paying fees to the financing company.
Different financing companies have different fee structures for late payments or those that come after the 30-day period. For example, you may have to pay the same fee for an additional 30 days, or a smaller fee for every day the customer is late.
Hence it’s important to read the conditions carefully and ensure – to the best of your ability – that your customer can pay for the order in a timely fashion.
Read more about: How SMEs Can Obtain Non-Collateral- Financing?
As is often the case with short-term financing, the costs can be steep. Take our example above: if you are paying 3% on a 30-day cash advance, that comes out to an annual percentage rate (APR) of 36.5%, much higher than a traditional small business loan.
Because you are depending on your customer to pay back the money, you run the risk of late payments eating away your profits or even putting you in the red after you account for the fees.
PO financing may sound a bit like invoice financing, another type of cash flow solution.
But there’s a key difference: invoice financing implies that your business has already delivered the goods or services and are merely awaiting payment.
At this point, your business can sell the unpaid invoices to a financing company for a cash advance.
The finance company may even handle the collection of payment on your company’s behalf and then pay you back, after taking a fee.
compare the initial fees (and late fees) with your profit margin to make sure the costs are worth it. Make sure there are no additional hidden fees, like processing or due diligence fees.
How fast can the company approve your request and get you the financing? If you’re looking for a cash advance, it means you have a pressing business need, so check how long it will take. Look for testimonials and reviews online.
It’s best to work with a financing company that is specialized in, or at least experienced with, your particular industry.
This will make the transaction smoother since they’re familiar with the supply chain.
look for a third-party financing company that is responsive. Even better is one that will give you a dedicated account manager you can be in touch with in case you hit a snag.
Read more about: Venture debt vs. Venture Capital, What is the best for start up founders?
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
