Purchase Order Financing
How much are you looking for?
$25,000 – $10,000,000+
1.5% – 3.5%
24 – 48 Hours
Benefits of working with SMB Compass
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 in order to secure funding for a loan with the purpose of filling 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 placed by a customer, which offers business owners flexibility when it becomes a challenge to fill active orders which in turn keeps your cash flow stable.
Who Can Use Purchase Order Financing?
Companies that process purchase orders from customers are primarily small businesses who can take advantage of PO financing.
A purchase order is a contract sent by buyers to sellers indicating the quantities, prices, and types of products or services they are looking to purchase.
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 is able to easily fulfill orders.
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.
What are the Benefits of PO Funding?
PO financing is beneficial for small business owners who need financial support in fulfilling customer orders. It gives borrowers the ability to accept and fill orders of all sizes eliminating the need to turn down new business.
Compared to other types of traditional lending options, PO funding is also typically easier to qualify for, making this lending option attractive. The three main advantages associated with it are speed, liquidity, and the ease of credit (qualifications) requirements.
The Speed of Application Approvals
Unlike traditional bank loans, the Purchase Order financing applications require minimal paperwork and you can generally receive the funds within 24 to 48 hours.
Once a borrowing company sets up a purchase order funding relationship, they can be confident that once a large order comes in, they can fill the order quickly.
This solution is different from other lending options for the simple reason the purchase order itself serves as collateral that secures the funds. This often speeds up the application and qualification process because the lender often does not have to take as much time with documentation and underwriting.
Once the value of a PO is established, the lender in most cases makes their qualification decision quickly. Once an approval decision is made, funds arrive much quicker than with traditional bank loan products.
Many business owners claim a recurring roadblock that constrains them is a lack of working capital. No business owner ever wants to turn down new orders or growth opportunities, but unfortunately without adequate cash flow, it becomes impossible to meet expenses and fill orders without support.
On the other hand, PO funding for small businesses ensures that capital is available whenever they receive new purchase orders, allowing them to fulfill all of their orders, regardless of the size.
In addition to an ability to fill all orders, taking advantage of PO financing will also keep other credit lines and other sources of capital available for future expenses. Instead of using operational cash flow to fill purchase orders, purchase order financing allows you to free up funds to be utilized elsewhere.
With PO funding, lenders are more concerned with the credit rating of your clients rather than your business’. They will examine the credit history of your customers and gauge the level of risk they will assume if your application is approved. This means there’s a high probability you can qualify for PO financing, even if you don’t currently have a strong credit rating.
You need to demonstrate that your clients have a strong history of paying their invoices in a timely manner. The more you can prove that they can fulfill their end of the agreement, the higher your chances for approval.
How does Purchase Order Financing work?
While other types of business lending options typically involve interaction between a lender and borrower, PO funding many times involves more participants. In fact, 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 order. The fourth party is the lender that is providing the working capital used to pay suppliers.
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.
Step 1: Receiving a Purchase Order from the Customer
The first step occurs when the borrowing business receives a purchase order from their 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 amount 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 fee 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 orders are the primary asset that most businesses use to secure this kind of funding. A PO is the 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 are accounts receivable. Accounts receivable 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.
What is the difference between Purchase Order Financing and Invoice Factoring?
Both PO financing and invoice factoring are lending sources that accept assets the borrowing business can pledge for collateral in order to secure funding. As with any B2B sale, there are specific steps that take place.
The first step is an order placed by the buyer from the seller. Once the order is received, the seller fills the order via their suppliers. With the details in hand, the order is shipped and delivered to the buyer.
The buyer receives their order along with an invoice. That invoice is owed to the seller unless a purchase order funder provided the funding for the order.
PO funding solves the liquidity need for the borrowing business at the time an order is received and filled. On the other hand, if an order is shipped and the invoice is created, the invoice can be used for invoice factoring if there are no purchase order financings generated.
The difference between PO funding and invoice financing is the time in which the goods are shipped and a borrowing business receives payment. With purchase order funding, the goods are yet to be shipped, which makes the transaction a higher financial risk for the lender.
With invoice factoring, the goods or services have already been delivered and accepted, which reduces the risk for the lender and ultimately will provide lower rates and fees for the borrower.
What are 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. Below is a list of factors that will have an effect on most lenders’ decisions when they consider rates for PO financing agreements.
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?
How do you use PO financing?
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.