Companies know how damaging it can be for their reputation if they fail to deliver, or worse, cancel their customers’ orders because they lack the capital needed. Unfortunately, many businesses often fall into that situation. As a result, they would have no other choice but to turn down large orders which could have been beneficial for their company’s growth.
For companies experiencing cyclical cash crunches or fast growth and need an additional cash flow boost to meet customers’ orders, purchase order financing can be of big help. This article will outline what PO financing is, how it works, and discuss PO financing rates.
What is Purchase Order (PO) Financing?
Purchase order (PO) financing is a type of business funding option wherein the company applies for financing to fulfill customers’ orders. The cash from the PO financing can cover the costs associated with the orders so that you can deliver the goods to your customers on time. Once approved, the financing company will pay the business’ suppliers and the suppliers will deliver the goods once completed.
PO financing gives you the confidence to fulfill large orders, so you won’t have to worry about turning down customers. The ability to deliver your customers’ orders on time will help build your business reputation, grow your customer base, and increase your sales.
How Purchase Order Financing Works
For some, the process for purchase order financing can sound complicated. But with the steps broken down, many would realize that it’s actually a straightforward process.
Here’s a simplified version of how PO financing works:
1. A customer places an order, and the purchase order is made
The process of PO financing typically starts when the business’ customer places an order. Upon seeing the order’s volume, the business owners and managers can determine whether they can afford it or not. If it’s the latter, only then would they decide if they would need the PO financing company’s help.
2. The business sends the PO to the supplier and gets an estimate of the costs
Before the business goes to the lenders to apply for PO financing, they would have to send the PO to their suppliers to estimate the costs. This is a crucial step as financing companies would ask for an estimate to know how much they would have to pay the business’ suppliers.
3. Purchase order financing application
Once you have the estimate from your supplier, you can start to process your PO financing application. The approval and amount of funding they will provide would primarily depend on the type of business you run, supplier reputation, and your customer’s creditworthiness. In general, PO financing companies can finance a portion (80% to 90%) or the purchase order’s full price.
4. The lender approves the financing and funds the PO
Unlike other financing options, the financing company doesn’t hand the cash over to the business. Instead, the lenders pay the supplier directly. After the supplier receives the payment, only then will they start working on the orders.
5. Supplier fulfills the order
Suppliers ship the products directly to the business’ customers. Once they receive the products, the customers will notify the company. The business then creates the invoice and sets the payment term (30, 45, or 90 days).
6. Customer pays the PO financing company
PO financing also makes use of invoice factoring to reduce the risk of default. This means that the business, after sending the invoice to their customer, the business may also have to give up their ledger to the PO financing company. The financing company will then handle the payment chasing and collection.
7. The financing company pays the business
Once the customers pay the invoice in full, the PO company deducts the amount borrowed by the business from it, plus the fee for the services. The financing company then gives the remaining balance back to the business.
PO Financing Rates
While PO financing can be one of the best ways to address a cash crunch, it’s also worth considering that the cost of funding might be higher compared to traditional financing. PO financing is a type of unsecured financing. In other words, without security to fall back on, the lenders would be taking a significant risk on this arrangement. The fees reflected on this type of financing are their way of mitigating the risk.
As for the PO financing rates, charges may vary from one financing company to the next. In general, financing companies can charge a 3% to 6% interest rate per month. Other lenders may also offer a 2% interest rate with 7 to 15 days payment terms.
Purchase order financing provides a way for businesses to improve their cash flow. With enough capital, businesses can ensure timely order delivery and accommodate customers’ orders regardless of the volume or the available capital you have on hand.
However, it’s always a good practice to read the contract’s fine print first before signing. This way, you’ll be aware of the PO financing rates and whether or not your business can afford them.
Nevertheless, PO financing could provide a way for businesses to improve their margins without going through the hassle of applying for traditional loans.