What is PO Financing, and How Do Purchase Order Financing Rates Work?

Ezra Cabrera

August 30, 2021
purchase-order-financing-rates

 

Key Takeaways

  • Purchase order financing is a viable financing solution mainly used by wholesalers, resellers, and government contractors in fulfilling large (or bulk) customer orders.
  • Purchase order financing rates can be more expensive than other types of loans. Each lender will have different terms, but will generally consider the business and its client’s creditworthiness and purchase order amount when deciding on the rates.

Businesses working in wholesale and exports may need additional cash to accept and fulfill large customer orders. These types of companies are not foreign to cash flow gaps as their capital often becomes tied up in outstanding customer invoices. When this happens, the business owner needs to look for an alternative source of financing to sustain his or her business operations.

This is where PO financing comes in. In this article, we’ll break down all you need to know about purchase order financing. 

What is Purchase Order Financing?

PO financing is a popular business financing solution wherein the business uses their purchase orders (PO) to get funding. A purchase order, or PO, is a contract that outlines the quantity, price, model, and types of products the customer wants to buy from a business. The customer’s orders are usually made in bulk, and if the company doesn’t have enough cash flow to fulfill the orders, they can turn to PO financing for help.

Unlike traditional loans, where the money will be wired to your account after approval, PO financing providers will pay your suppliers directly. Once the manufacturer or suppliers confirm the payment, they will start working on the orders and ship the products directly to the borrowing business’ clients.

In most cases, the lending companies will fund the entire purchase order amount, though some may only fund a portion of it. In the latter case, the business has to use its resources to fill the gap. In general, the amount of PO financing you’ll be eligible for will depend on several factors – one of them being your customer’s credit score.

The most common type of businesses that apply for PO financing include:

  • Wholesalers
  • Distributors
  • Government contractors
  • Import and export companies
  • Resellers

 

Why People Choose Purchase Order Financing

Businesses such as wholesalers, government contractors, and importers and exporters often receive bulk orders from their customers. The client sends over a purchase order, and once the business agrees to the terms, it will become a legally binding contract between you and your clients.

The problem is that the company may have many large orders to fill, and sometimes, their cash flow may not be enough to fulfill each of them. Instead of turning customers away and missing out on the profits, the business can turn to PO financing to help fund the orders. By not rejecting the order, it allows the business to maintain smooth operations and their reputation.

PO financing can also help businesses in these types of situations:

  • The business’s current cash flow can’t keep up with its growth and demand
  • The business is experiencing cyclical cash flow gaps
  • The business needs additional capital to meet the demand of seasonal sale spikes

 

How PO Financing Works

Here’s a step-by-step breakdown of how the purchase order financing process goes:

  1. Reaching out to the PO financing company. The first thing to do is to reach out to a purchase order financing provider. You’ll have to send them the purchase order, along with a quote from your supplier outlining how much the project will cost. From there, they will evaluate the application and decide. If you have an existing relationship with the lending company, then you’ll probably have better chances of getting approved.
  2. PO financing provider approves your application. Assuming that the lending company approves your application, they will then produce the money and wire it directly to your supplier or manufacturer. The PO financing company will not transfer the funds to your account.
  3. The supplier/manufacturer verifies the payment. After the lenders send the money, the supplier confirms the payment and starts working on the project.
  4. Supplier sends the products to the clients. Once the production is complete and the products are ready, the supplier will deliver the goods directly to the clients.
  5. Customers receive the invoice. After the customer confirms they’ve received the products, the business sends an invoice to the customers. The customers, in turn, must pay their dues within the agreed time.
  6. Customer pays the financing company. With PO financing, the customers won’t be paying the business directly. Instead, they pay the PO financing company. Some businesses may be uncomfortable with this arrangement, as it lets their customers know they’re using PO funding. However, some PO companies can be discreet and make it seem like they’re a representative from your company when asking for payments.
  7. The business gets paid. The PO company will deduct the financing amount they provided, plus the interest rate, after receiving the customer’s payments. They will then transfer whatever is left of the payments to the borrowing business.

It’s worth noting that if your customers don’t pay their dues on time, you may incur more interest for the financing. It’s essential to ensure that you’re customers are creditworthy before implementing this type of funding. The last thing you want is to damage your relationship with both your customers and the financing company.

 

How Purchase Order Financing Rates Work

Purchase order financing can be a life-saving solution for some businesses. However, when applying for one, borrowers can typically expect the financing to be costlier than other financing alternatives, such as business lines of credit. In return for the convenience, the lenders may charge companies with higher rates and fees.

PO financing companies will charge rates based on the utilized funds. Utilized funds refer to the amount of funding the financing company wired to your supplier.

Suppose you were approved for a PO financing worth $20,000. The amount you’ll pay in fees will depend on the utilized funds, which in this case, is $20,000.

Some PO financing companies may also offer a tiered structure and deal with payments based on milestones. For instance, if the purchase order is worth $100,000, the financing company may pay the entire amount in installments. They could pay a 20% deposit, followed by a 30% payment halfway through the term, and pay the remaining 50% upon shipping. This method is much cheaper for businesses as the PO company may choose to finance each payment separately.

 

Common PO Financing Rates

Ultimately, the cost for the financing will depend on the lender and the size and complexity of the transaction. The business’ credit score, as well as the customers’, will also play a role in the rates that the PO financing company determines.

On average, purchase order financing rates can go up to 3% of the utilized funds per 30 days. Other companies may charge on a rate model, such as:

  • 3% for the first 30 days, then an additional 0.1% per day or 1% per 10 days after the first 30 days.
  • 2% for the first 20 days, which increases by 1% every 10 days thereafter.

Each lender structures its financing terms differently. Be sure to ask what their rates are and how it works upon application. This will help you determine if your company will still have some profit left from the transaction.

 

How to Find the Right Purchase Order Financing Lender

Purchase order financing is a common financial solution used by various businesses. That said, finding a lender that will help fund your PO won’t be difficult. The challenge lies in finding the right one for your business.

Since the purchase order financing rates can be expensive, it’s crucial to find a lender that will give you the best deal based on your current business needs and situation.

When finding the best PO financing company for your business, consider the following factors:

  • Expertise in your industry
  • Transaction flexibility
  • Purchase order minimum amount
  • PO financing costs
  • Capital sources

It also helps to shop for PO financing from multiple lenders. This way, you can compare offers and choose which one is most affordable for your business.

 

How to Qualify for PO Financing

One thing worth noting about PO financing is that it’s not for everyone. To qualify for purchase order financing, the business must meet the following requirements:

  • Selling ready-made, assembled products
  • B2B or B2G business
  • Purchase orders must be worth more than $20,000
  • At least 20% profit margins, computed by comparing supplier costs to the price the business charges their customers
  • Work with creditworthy customers
  • Work with reputable suppliers who can deliver the goods on time

 

The Bottom Line

PO financing brings a lot of benefits to the table. It gives businesses a chance to fulfill large customer orders, so they won’t have to turn clients away. But know that it is more expensive than other business financing options, especially if the business doesn’t have a good credit standing, or their clients aren’t creditworthy.

If you decide to move forward with purchase order financing, be sure to review the terms and the rates. This way, you can determine if it’s the best financing solution for your business.

Ezra Cabrera
Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.

Related Articles

How Much Does Instacart Pay?

How Much Does Instacart Pay?

Key Takeaways What is Instacart? How Does Instacart Work? How Much Does Instacart Pay? Pros and Cons of Driving and...