What Is Purchase Order Financing?
If you’re a distributor or reseller who does not have the funds to fulfill customer orders, purchase order (PO) financing may be for you. Although PO financing tends to run on the expensive side, it can be a useful financial tool for businesses that have exhausted their other financial options.
What is purchase order financing? Is it right for your business? Keep reading to find out!
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What is Purchase Order Financing?
If you don’t have the money to finance a purchase order, and your manufacturer will not extend credit until your customer pays, then purchase order financing may be your best option.
In a PO financing arrangement, the financial company foots the bill for most, if not all, of the cost of manufacturing the products. Because your customer is ultimately the one to repay the PO financier, even less-than-creditworthy merchants may qualify for this type of financing (if they’re working with creditworthy customers).
Who Qualifies for Purchase Order Financing?
Due to the fact that repayment is based on your customers‘ creditworthiness, your credit score is not a big consideration. However, there are other qualifications that you need to meet.
PO financiers work with distributors, resellers, and other businesses that receive purchase orders in many different industries.
Qualifications will vary depending on the financier you’re working with. Here is what most will require:
- A verifiable purchase order
- A creditworthy customer
- A proven track record of similar transactions
Additionally, most PO financiers will have a minimum transaction volume and will require a profit margin around 20% (though some will have lower or higher profit margin requirements).
How Does Purchase Order Financing Work?
Purchase order financing is a somewhat complicated process, involving at least four separate parties: you, your manufacturer, your customer, and the PO financing company.
Here is how the arrangement goes:
- Your customer sends you a purchase order.
- You make an arrangement with a PO financier. You order the supplies from a manufacturer; the PO financier pays a portion (up to 100%, but often lower) of the cost, and you pay the rest.
- After completion, the manufacturer sends the supplies to your customer. You invoice the customer.
- Your customer pays the PO financier. The PO financier deducts the principal, plus a fee for their services, and then sends the remainder to you.
If your customer takes a long time to pay their invoice, you may want to consider factoring the invoice. Often, invoice factoring is less expensive than PO financing.
What Does PO Financing Cost?
PO financing tends to be more expensive than other forms of financing.
In general, based on the rates we viewed on various PO financing sites, rates will range between 2% and 6% per month. In other words, excluding other fees, you can expect an annual percentage rate (APR) of roughly 24% – 72%.
Fee structures will vary depending on the PO financier you’re working with. However, many companies will charge a flat percentage for the first 20 or 30 days, and then begin charging on a daily or weekly basis after that.
For example, you might be charged 5% of the principal for the first 30 days, and then an additional 1.5% per week after that.
Alternatives to PO Financing
Many businesses use PO financing because they are not creditworthy enough to access other, less costly, forms of financing. If you are in that situation, there are still other forms of financing that may work for you.
Some lenders specialize in lending to businesses with poor credit. Check out this list of our favorite lenders for merchants with bad credit scores.
Another option is to use invoice factoring instead of, or in conjunction with, PO financing. Because factoring is also dependent on your customers paying, it may be an option for uncreditworthy businesses.
Although invoice factoring still tends to run on the expensive side, it’s usually less expensive than PO financing. You may have the option of factoring another invoice to fund your purchase order or paying off your PO loan by factoring your customer’s invoice after the products have been delivered. Check out our favorite invoice factors here.
As always, do the math to ensure that you’re saving as much money as possible.
PO financing may be the best option for businesses that need help fulfilling a purchase order. As long as you have a verifiable purchase order and an acceptable profit margin, most businesses will be able to find PO financing of some sort.
However, because this type of financing is not the only one you might have available, it’s best to explore and compare other potential options to ensure you’re saving as much money as possible and getting a form of financing that will work for your business.