Purchase Order Financing is an alternative way to access working capital. Purchase Order Finance gives corporates borrowing alternatives. SMEs can access funds to pay the suppliers before invoicing the buyers. Cash flow problems represent significant issues for small business owners.
For example, a borrowing company receives a significant order from a buyer. At this time, the borrowing company does not have enough liquidity to pay the supplier upfront. So, the borrowing company uses the PO to access liquidity by applying for funding to a financial institution.
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What is a Purchase Order?
PO (Purchase Order) is a commercial document. The buyer sends the Purchase Order to the supplier to request the purchase of specified products. At this stage, the form is not yet a contract.
The Purchase Order contains the name of the buyer and supplier, a detailed description of the goods ordered and the price.
The applying company must fill all this information to access purchase order financing.
Why Purchase Order Financing?
PO Financing shares a lot of similarities with short term loans. However, Purchase Order Funding is used to pay the production of the goods specified on the PO. The applicant of PO loans and PO funding can not use the funds to make any other payment.
This financing solution makes sure the buyer’s orders are fulfilled and keeps clean the track record of (other) business loans.
How does Purchase Order Financing work?
You receive a large purchase order from your buyer (a well-established, creditworthy corporate). A large order requires you to procure several components from your manufacturers ahead. Imagine if you were a supplier of electronic components and you just received a million-unit order from Apple. To produce those microchips, you need chipsets and semiconductors from various manufacturers.
How could you accept the PO if you did not have the financial capabilities to pay your manufacturers? Is there a way to access purchase financing?
Use the Purchase Order to secure financing from a financial institution.
With the PO in your hand, you can inquiry with higher bargaining power, the intent to purchase from your manufacturers.
At this stage, you can get in contact with a lending institution and specify all the funding requirements. Purchase order financing is made possible because your buyer is a well known and reputable company. Thus, implying that the buyer will honour the commitment. The are two types of Purchase Order: revocable and irrevocable. (more information to be linked at the bottom of the page).
The financing lender reviews your application process and set up a credit limit. Once the credit check and the due diligence is confirmed, the purchase order financing company will provide the financing options available.
The financing allowances are usually a percentage, between 30% to 70%, of the amount of the Purchase Order. The remaining part has to be paid by the supplier itself. Thus it implies that some funds need to be already available.
The lender pays the manufacturers directly for the materials. Then you receive the materials, and the production of the microchips can begin. Once the microchips are finalised and ready to be shipped to Apple, there are two scenarios:
- If the payment terms are “Cash on Delivery”, then Apple pays the invoice to the supplier right away.
- Invoice the buyer (Apple) with credit terms (e.g. 60-90 days). Then use the invoice to apply for Invoice discounting. Thus, obtaining further financing immediately.
With the cash on hand, now the supplier can settle the Purchase Order Financing with the lending institution. The fees and costs are pre-agreed at the time of the lending agreement, so there should be no nasty surprises.
How to apply? Traditional or Alternative purchase order financing company?
Cash flow represents one of the significant problems SMEs face when large purchase orders come from buyers. Sometimes this issue prevents the purchase of goods. Hence, holding corporates to run the business efficiently. It also creates even more short term cash flow imbalances. Thus, having access to finance purchase orders represents a solution to access working capital.
The borrowing company can apply with traditional or alternative purchase order financing companies. Traditional lenders include banks (for example, Bank of America purchase order financing) and factoring companies (financing purchase order). Alternative lenders are FinTech companies that can finance purchase orders (and trade finance products).
What are the interest rates for purchase order financing?
The actual rate for purchase order financing depends on many factors. For example, the size of the purchasing order and the agreed time of repayment. Other factors are the business relationship between the parties and their financial stability.
PO financing rates versus forgo of business opportunities
The trade-off between declining the order from your buyer, versus the fees paid to the purchase order financing institution, is favourable to use the funding option.
Accepting the order from the buyer allows the relationship with the customer and supplier to get going. Also, new sales, especially from large orders, are always a mood booster for the entire team.
What industry do companies qualify for Purchase Order Financing?
The industries qualify for purchase order financing are characterised by large orders from suppliers. The business relationship may also be not bound to the domestic border. Purchase Order Finance also applies to international / cross-borders orders. Some industries are:
The growth of alternative lenders made Purchase Order Financing a funding option worth considering. In recent year, many startups are finding PO Financing more accessible.
Purchase Order Financing: the difference between traditional lenders and alternative funding options.
Traditional lending financing companies are banks and factoring companies. They may sometimes refuse to provide liquidity against the purchasing order. Purchase orders may not be seen as collateral assets to support the financing PO application. The requirements of conventional lenders are usually strict and onerous. One of the many conditions is about the size of the purchase order to be significant. It helps to justify the resources allocated to onboard the new customer. Hence, PO funding companies may reject many applications due to stringent requirements. Conversely, SMEs tend to have smaller purchase orders compared to multinational corporates.
Alternative lending companies can solve cash flow issues for small and medium size companies.
SMEs have limited credit lines compared to big corporates. Thus, Small-medium enterprises struggle to access working capital.
Alternative sources of PO financing companies ask for less demanding conditions. Thus, allowing companies to access working capital more simply and efficiently.
On the one hand, banks can indeed handle a large purchase order. On the other hand, FinTech companies usually have a faster onboarding protocol. It allows to cut the time between the initial inquiry from the client, to the moment when the funds reach the manufacturer’s bank account. It is usually a few weeks for the first transaction. Shorter time once the funding process is reoccurring.
Carefully consider all the options when choosing your purchase order financing lender.
Apply for PO finance with Traditional Lenders:
Traditional lenders need to follow Government requirements and guidelines to provide financial services. Also, the lending companies need to be compliant with the international regulatory framework. Hence, the borrowing company needs to fall within specified guidelines to access Purchase Order Finance. The imposition of stringent regulation requires traditional lenders to use a lot of resources to assess PO finance application.
The applying company usually needs to provide financial information for the past three years. Thus, it usually requires a lengthy and thorough paper form application.
Collateral assets are also required to access PO financing. Collateral assets are real estate, stocks, bonds or even cars.
Apply for Purchase Order Financing with an Alternative Funding company
FinTech companies such as Velotrade play an essential role in developing an ecosystem where small entities can access financing more efficiently.
To operate in this environment, FinTech companies need to follow regional and international regulatory requirements. The requirements are money lending license, anti-money laundering procedure and other. Velotrade operates in Asia and is regulated by the Securities and Futures Commission of Hong Kong.
The onboarding is a very straightforward process. The credit team assesses the profile of the counterparts involved in the transaction. The team is in charge to run the Due Diligence and the KYC procedure. All the documents and signatures are exchanged electronically.
PO Financing may be the solution you need: Purchase Order Financing pros & cons
PO Financing is a way to solve cash flow issues. It allows small business to fulfil an order that would not have been possible otherwise. However, purchase order financing may not be the solution to every company. For example, low-margin businesses may need to access other funding alternatives.
It worsens the liquidity ratio
It is suitable for high margin businesses.
Purchase Order Financing versus eCommerce financing
E-commerce finance is suitable if you have an e-commerce shop that sells products online in a marketplace. The financial company grants your business a revolving loan. The amount of the loan is based on the transaction history of your e-shop. Consult this guide to check the requirements and the application process for e-commerce financing.
What’s the difference between PO Financing and invoice discounting?
Purchase order financing should not be confused with invoice discounting. PO Financing and Invoice Discounting are both trade finance solutions. They are both issued by financial institutions. The difference is when the funds are transferred, before or after the issue of the invoice.
PO Financing versus Invoice Discount
If the transaction is at this stage, where:
- The goods have been produced and shipped
- The buyer has been invoiced already
Then, companies should consider invoice financing (Invoice Discounting) instead of purchase order financing. Basically, with Purchase Order Financing, the financial intermediary releases the funds on behalf of the buyer. The manufacturer has not already issued an invoice. The lending company transfers the funds to the manufacturer. Hence, the funds are used as a payment to begin the production.
Purchase Order Financing versus Factoring
Factoring can be the solution for your cash flow needs as it is usually cheaper than Purchase Order Financing.
Factoring methods are similar to invoice discounting. The borrowing company transfers the ownership of the invoice to the lending institution.
Verified purchase order. How do you confirm the purchase order?
To access purchase order financing, the financing lender needs to validate the purchase order. An initial assessment involves the checking of the order quantity and price. Other parameters are the consistency of the price and the market price benchmark. Furthermore, the delivery date, incoterms and other variables are also analysed. Lastly, before releasing the funds, the financing company takes into consideration how often the customer pays the suppliers. More info about PO can be found here