Purchase Order Financing

Get access to revolving funds when you need it most.

Serine Alejandro

December 21, 2020

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Loan Amounts

$25,000 – $10,000,000+

Terms

Revolving Credit

Rates

1.5% – 3.5%

Speed

Less than 30 days
Purchase Order Financing

What is Purchase Order Financing?

Purchase order financing, also known as PO financing, is a funding solution for businesses that lack the working capital to fulfill purchase orders. In turn, lending companies give business owners the capital they need to pay suppliers and vendors.

Essentially, PO funding capitalizes on the active purchase orders that a business uses as collateral to secure funding for a loan to fill their purchase orders.

By using this source to boost working capital, a small business can borrow up to 100% of the money or cost needed to fulfill an order the customer places. This offers business owners flexibility when it becomes a challenge to fill active orders which in turn keeps your cash flow stable.

Can Use Purchase Order Financing

Who Can Use Purchase Order Financing?

Who Can Use
Companies that process purchase orders from customers are primarily small businesses that can take advantage of PO financing. As a primary requirement, the business should be selling finished, assembled, and completed products. This means that a company that sells raw materials, instead of completed ones, won’t qualify for the financing.

A purchase order (PO) is a contract that buyers send which indicates the quantities, prices, and types of products or services they are looking to purchase. These buyers usually order in bulk. However, without the right amount of cash, the suppliers cannot fulfill this order. For that reason, they usually apply for purchase order financing.

This type of funding resource is most commonly used by companies that are rapidly growing and, or not able to fulfill the quantity or size of orders they have committed to. Companies that can take advantage of this financing plan include:

Start-up businesses

Wholesalers

Businesses with poor credit rating

Resellers

Government contractors

Manufacturers

Import and export companies

Purchase Order Financing work

How does Purchase Order Financing work?

Purchase Order work
While other types of business lending options typically involve interaction between a lender and borrower, PO funding many times involves more participants. To be precise, four parties are usually involved in every transaction.

First, there is the seller that received the purchase order, followed by the one seeking financial assistance to help fulfill the order. The second party is the customer that placed the order with the first party. The third party is the supplier that the first party purchases goods or services from which enables them to fulfill their customers’ orders. The fourth party is the lender that is providing the working capital used to pay suppliers.

Small businesses of all sizes use purchase orders to balance and maintain their operating cash flow. Without it, they would be unable to support new and existing orders. Filling purchase orders is critical for a business to stay functioning, and PO funding is one way to accomplish this. By taking advantage of this source as well as other lines of credit, a small business can easily fulfill orders.

The process itself consists of seven key steps. A purchase order is received from a customer which contains a breakdown of costs from the supplier. PO is submitted to the lender and the lender pays the supplier. The supplier in turn provides the goods to the customer who then pays the lender, and the lender pays the final balance to the borrower.

Here’s a breakdown of the steps involved in Purchase Order (PO) Financing:

Step 1: Receiving a Purchase Order from the Customer

The first step occurs when the borrowing business receives a purchase order from its customers. Every PO financing relationship begins when the borrower determines they need or want financial support to fill their orders. Whether their cash flow cannot support the order, or the business wants to keep funds available for other costs, at some point the borrowing business determines that PO funding can help their business.

Step 2: Supplier Provides Cost Breakdown for Order

Once a purchase order is received from a customer, the next step is to determine what needs to be done to fill the order. Once the order is placed, the borrowing business provides the PO information to their supplier, and the supplier provides a cost breakdown to the borrowing business who details the expenses associated with filling each specific order.

This information is essential when applying for PO financing because this is what determines the number of funds necessary to fill the order.

Step 3: Submit Purchase Order to Lender

Once the amount needed is established from the supplier, the borrowing business can reach out to their lender with a detailed breakdown of the expenses that the loan will cover. The lender typically will need to examine the purchase order details and evaluate the cost break down to determine the eligibility for the borrower’s application.

Step 4: Lender Pays the Supplier

After the lender receives the purchase order along with the cost break down and assuming the borrower qualifies for financing, the lender then pays the supplier. This step is one that is commonly misunderstood. Instead of paying the funds directly to the borrower or directly to the customer, like most other forms of lending, the lender pays the supplier to complete the purchase to the customer.

Step 5: Supplier Delivers the Goods to the Customer

Once the supplier receives payment from the lender, the next step is for the supplier to make the product, ship or deliver the goods, and invoice the customer. PO financing allows more small businesses to fill their customers’ orders by qualifying to have a lender pay the supplier who in turn will complete the order.

The lender makes the payment to the supplier enabling the customer to receive their order, giving the borrower the ability to transfer the cost of filling an order to a lender.

Step 6: Customer Pays the Lender

Once the customer receives their order from the supplier, the next step is for the customer to pay the invoice directly to the lender. Once the customer receives their purchase, they make their invoice payment, which goes directly to the lender.

Step 7: Lender Pays Balance

Once the invoice is paid to the lender by the customer, the borrowing business receives the balance from the lender. Typically, the rate associated with the purchase order agreement will be established by the lender and applied to the cost of filling the order.

It is important to note that the rates are applied to the cost of the order, not the cost of the purchase order. Once the lender receives the invoice payment from the customer, the lender receives their payment via the feed rate and returns the outstanding balance to the borrowing business.

What type of collateral is used for Purchase Order Financing?

Unlike other types of lending services, PO funding is a specific type of lending vehicle that only considers purchase orders or accounts receivable as assets to be used as collateral to secure funding. Most asset-based lending sources also consider inventory, equipment, or real estate as collateral, but this financing option is restricted to the following types of assets:
purchase order collateral

Purchase Orders

Purchase orders are the primary asset that most businesses use to secure this kind of funding. PO is a document that is generated by the buyer to authorize a transaction with the seller.

PO’s typically outline the terms of the sale, which include the price of the goods or service, the quantity ordered the terms of payment, the shipping date, and delivery details, along with other incidental details associated with the order. Once the purchase order is accepted by the seller, the purchase order itself can be used as collateral when the seller applies for financing.

The LTV (or loan to value ratio) for PO financing agreements is typically between 30% to 40%, but once the goods are delivered or the services are rendered, the purchase order becomes an invoice and the remaining 40-50% of the invoice can be advanced from the lender to the borrowing business.

Accounts Receivable (A/R)

The second type of asset that can be used for purchase order financing is accounts receivable. Accounts receivable (A/R) is money that is owed to the business after a sale has been made or services have been rendered from the seller to the buyer.

For most purchase order lenders, the accounts receivable directly associated with the purchase order funded will allow the lender to collect payment after the supplier delivers the goods.

Typically, the LTV ratio for accounts receivable is up to 90% of the face value of the invoices associated with the purchase orders. These rates can vary from lender to lender and will be determined based on different characteristics of the borrowing business and purchase order agreements.

Lenders will typically consider the credit strength and quality of the customers, the payment terms that are offered in the purchase order agreements, as well as the diversification of the client base associated with the borrowing business.

PO Financing Rates and Fees

PO Financing Rates and Fees

Purchase order funding rates and fees are based on a variety of different factors that the lender considers. Because of the nature of the financial risk associated with this type of financing, the rates and fees are often more expensive than with other traditional bank financing sources.

Often, rates and fees range from 1.5% to 3.5% per 30-day period. It is important to highlight that the rates and fees are applied also to the cost of filling the order, not only the purchase order value.

For example, if a borrower receives a 100% gross margin for a purchase order, and the purchase order has a total value of $100,000, the cost of filling the order would be $50,000. The rates and fees paid by the borrowing business after the customer is invoiced will be applied to the $50,000 cost of filling the order, as opposed to the $100,000 that is invoiced to the customer.

Different lenders take into account several different factors when evaluating applications. The lender will analyze the credit risk of the purchase order by assessing features of the borrowing business along with their client base when determining the rates, fees, and qualification status.

What are the Qualifications for PO Financing?

Aside from the fast approval benefit of PO financing, turns out, it’s also relatively easy to qualify for. All you have to do is to have a business that meets the following requirements:

Sell finished, assembled products

Accept purchase orders in large amounts

Sell to other businesses or government customers

Have reputable suppliers that offer high-quality products

Profit margins should reach at least 30%

Customers must have a good credit background

Business owners interested in purchase order financing must remember that even if they don’t have a good credit rating, they can still qualify. As long as they can prove their customer’s creditworthiness and follow the guidelines above, they can enjoy the benefits of purchase order financing.

FAQ About Purchase Order Financing

What is purchase order financing?

PO funding is a specific type of business financing source that uses a business’s purchase orders as collateral to secure the resources and capital necessary to fill their orders for their clients.

When a business doesn’t have the capital to fulfill orders, they can capitalize on the value of the purchase order itself in order to ensure the orders promised to clients are filled.

How do you qualify for PO financing?

The application and qualification process is determined by and based solely on the trade and credit history of customers, rather than the credit history of the borrowing small business, as is the case with other types of lending products.

With PO funding, the lender is primarily concerned that the borrower’s customers who are being invoiced are financially healthy, and able to make the invoice payments.

How long does the application process take for purchase order financing?

Fortunately, the application process is not document-intensive, unlike other traditional lending programs. Usually funds can be secured rather quickly with. Once the lender verifies the purchase order and confirms that the customer has a strong credit and trade history, the funds are approved, and the lender forwards payment to the supplier.

How do you use PO financing?

This type of funding is used by a variety of business for an array of different expense types. With PO financing, you are able to maintain business operations as efficiently and productively as possible.

Is collateral required for purchase order financing?

Unlike other types of asset-based lending sources, PO funding uses the outstanding purchase order as collateral to secure the funds.

Instead of using inventory, equipment, or real estate as collateral, you are able to capitalize on your existing purchase orders and obtain the funds you need in order to fill requisitions.

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