Specialist finance

What is purchase order finance?

Paying suppliers can often put pressure on your cash flow and make it challenging to meet customer demands, especially if your business has high sales growth but long invoice fulfilment times from your clients. Purchase order (PO) financing (also sometimes known as a "partial credit guarantee") can be a solution to this problem for businesses that meet the proper requirements.

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What is purchase order finance?

Purchase order financing is a form of financing that allows you to use the money from your customers' purchase orders (POs) as collateral. This enables you to access cash before your customers have paid you.

A purchase order (PO) is a document issued by a buyer to a seller, which authorises the seller to provide goods or services. A purchase order will typically contain information about what the purchaser wants, along with details of how and when payment will be made.

In simple terms, the purchase order is an official request from a buyer to its suppliers for the supply of goods and services at agreed prices and within specified delivery times. Buyers use it to specify exactly what they require and give details of payment terms and conditions. Purchase order finance is when the purchase order is used as security for a loan.

How does purchase order financing work?

A company that wants to sell its products to another business will issue a purchase order (PO). The PO is essentially an invoice for the goods being purchased. The purchaser pays for the product when it receives it, usually within 30 days. The payment is made directly from the company's bank account to the seller's bank account.

The seller then delivers the product and submits a copy of their receipt to a factoring company specialising in PO financing. The factor will make payment within 48 hours of receiving this documentation, minus any fees charged by the lender.

Can PO finance be shared by multiple companies?

You can share a purchase order with multiple companies. This is useful when you have multiple divisions or subsidiaries, as it allows you to provide financing for all of them through a single purchase order. Large businesses may also benefit from this feature because it enables them to provide financing for multiple companies simultaneously. Smaller businesses that want to finance several companies should also consider sharing their purchase order with other individuals or businesses that make purchases for those entities.

What type of businesses would benefit from PO financing?

One type of business that benefits from PO financing is one that requires large purchases. When purchasing large items like machinery or equipment, it may be difficult for businesses to get approved for financing because lenders have difficulty determining how much profit the purchase will bring in. However, if your company has a PO in place and can show how much money will be saved by purchasing these items through PO financing instead of paying cash upfront, then it makes sense for lenders to provide funding.

Another type of business that benefits from PO financing is one that needs regular supplies on a weekly basis but doesn't have enough cash flow available at that time because they are waiting on customers who owe them money before they can pay these expenses themselves. In this case, you can use PO financing to pay for your supplies and then get reimbursed by your customers when they finally pay their bills. This is a great way to take advantage of the fact that most companies don't need all of their cash immediately but can wait until it is earned by selling products or services before paying their expenses.

Here are some examples of businesses that benefit from purchase order financing:

Small businesses: Many small businesses don't have enough credit history or collateral to get approved for a traditional bank loan. Purchase orders offer an alternative to traditional financing that doesn't require any personal guarantees or collateral.

Manufacturers: Manufacturers often need to buy large amounts of raw materials before they've sold any finished products, which makes it difficult to get traditional loans. PO financing can help them bridge this gap without having to wait until they've sold their inventory first.

Startups: Many startups rely on outside funding to get started, but this process can take months or even years before they receive any money from investors or banks. PO financing helps startups get capital much quicker than through traditional means, which allows them to start their business sooner and grow faster than if they had waited for funding from other sources first. Purchase order finance for startups is uncommon, but can be applied for the right set of requirements.

Risks of purchase order finance

As a small business owner, you may not be aware of the risks associated with purchasing inventory on a purchase order basis.

Here are some of the risks you should be aware of:

  • If your customer doesn't pay for the inventory, then you are liable for the amount owed.
  • The credit risk associated with accepting purchase orders from customers is high because they can default or go bankrupt at any time without warning.
  • Despite these risks, research suggests that PO finance is still a good option for businesses to avoid losing opportunities, even when their credit capacity has reached its limit.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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