Why Businesses Should Choose Purchase Order Financing Over A Loan

Topics: Finance, Management

Purchase order financing helps resellers meet customer orders by funding the order. Resellers (also distributors or wholesalers) may receive a large order, which they aren't able to meet because the funds to fulfill the order simply aren't available. This is where purchasing order financing comes in.

In these cases, the reseller can avoid more traditional means of ordering financing, such as through a bank. Using purchase order financing is also easier to qualify for and sets up fairly quick.

Different From Invoice Factoring

It's important to not confuse invoice factoring with purchase order financing. With invoice factoring, the company has already delivered the product to the customer and is awaiting payment. To lessen the impact to cash flows, the company can take out a loan against this invoice.

With purchase order financing, the product has not been delivered to the customer because the company simply doesn't have the funds to pay their suppliers. A financing company can step in to pay the supplier and allow the order to be completed. The financing company will charge a fee for financing the purchase order.

The Many Advantages To Order Financing

The ability to fulfill customer orders is a sign of reliability. If you aren't able to fulfill certain orders because the funds aren't there, it can start a downward spiral in your business. Word will get out that you are having problems meeting customer demand. This can drive potential business into the hands of your competitors.

For a small fee, purchase order financing can allow your cash flows to begin slowly catching up to customer orders. At some point, you'll be in a position to finance some orders without the need for a financing company.

Also, you can avoid burdening your company with additional debt. Taking on more debt can weaken your financial position if you actually need debt later. Purchase order financing isn't a loan. Instead, it's an advance against future earnings. The customer will pay the financing company, who will then pay you, thus clearing out the advance.

Financing purchase orders are more flexible than a traditional loan, allowing you to borrow what's needed (or close to it) for completing customer orders.

How Purchase Order Financing Works

Purchase order financing is transactional based. This means you only pay for what you use. The advantage is overall lower cost.

Rather than the reseller receiving the purchase order funds, they are sent directly to the supplier. The customer will pay the financing company. Once payment is received, the financing company will subtract out their fees. The remaining amount is then sent to the reseller.

Resellers may not always qualify for 100% funding of a purchase order. However, a significant portion of the purchase order amount should be available, allowing the reseller to cover the remaining balance of the order.

A line of financing credit is opened for the reseller. However, if the reseller has poor credit, the line may be opened on the supplier and backed by them. As you can see, establishing purchase order financing one way or another isn't that difficult for resellers.

Example Transaction

Let's say you have a customer who has placed a $5,000 purchase order. Your cost from the supplier is $4,000. But this amount must be paid before you can take delivery or have the product shipped directly to the customer. The problem is that you don't have $4,000 to complete the purchase. At this point, the purchase order financing company steps in to help you complete the transaction.

Once the financing company sees that the transaction will meet all of their requirements, they'll pay the supplier directly. The supplier will then ship the product to your customer. At this point, you can invoice the customer. The customer will pay the financing company. The financing company will then pay you minus their fees.

Financing Company Requirements

There are usually a set of requirements that a reseller must meet to qualify for purchasing financing. These requirements vary across purchase order financing businesses. 

Again, the qualifications are usually not difficult to meet. The better your credit history, the easier it will be to qualify.

Here are a few common requirements:

  • Customers are commercial or government
  • Reseller must be profitable or meet a minimum amount of monthly earnings
  • Business type is reseller or distributor
  • Order meets a minimum size
  • Transactions have a specific profit margin (15% for example)

Conclusion

If you're a reseller and have a difficult time meeting certain purchase orders because of funding limitations, purchase order financing is probably a good option for you. You'll be able to continue growing your company by fulfilling customer orders that otherwise would have gone unfilled. Additionally, you'll be able to keep your company's reputation and reliability for fulfilling orders intact.
 
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