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What is Purchase Order Financing?

Purchase order financing is an alternative financing solution that businesses with POs can use if they’re short on working capital. It can be useful for small- to medium-sized and emerging consumer goods brands who need capital to pay suppliers to fulfill large orders and grow their business, without having to depleting their cash flow. 

Purchase order financing uses POs as collateral to secure funding. It’s a unique financing opportunity that lets you capitalize on income you’ll earn, but haven’t yet collected. It can give you some breathing room if you don’t want to take out a high-interest, more traditional business loan or dip into earned revenue that could be used for a host of other operational and business-related needs. 

Is it the same as invoice factoring?

Purchase order financing is often confused with invoice factoring, but in reality, there are significant differences between the two concepts. It’s important to understand each, so you have a clear grasp on which would be most beneficial in helping you achieve your goals with your business. 

Both PO financing and invoice factoring can help you when sales are surpassing incoming revenue. And while they’re both essentially just types of financing, they actually work in very different ways.

Purchase Order Financing vs Factoring

PO financing is capital you borrow to pay a supplier, using current purchase orders you have on hand as collateral. When you secure funds this way, a PO financing company will pay your supplier directly, allowing you to fulfill large orders while keeping precious capital on hand to use for other operational and daily expenses. Your customer eventually pays the PO financing company, not you, back.   

Invoice factoring, by contrast, is a loan you secure to help during periods where you’re waiting for payment on outstanding invoices for product that’s already been sent to your customer. Technically, you’re just selling your Accounts Receivable to a third party (an invoice factoring company), who’ll give you a percentage of your receivables upfront.   

Invoice factoring doesn’t deal with interest or collateral, and often can be much easier to qualify for. It’s essentially just an advance on what you’ll eventually earn anyway. Typically, the fee you pay for invoice factoring is much less than the interest rate on a conventional loan. 

How is it different from traditional lending?

Purchase order financing is different from traditional lending and conventional small business loans primarily in that PO financing is more of a short-term loan. But there are other differences too, and understanding them can help you determine which is the best option for your funding needs. 

Because purchase order financing involves the POs you have, potential sales tend to be more important than a balance sheet is. Cash flow isn’t generally a huge factor in the approval process, and you can often get approved quickly - all of which are attractive qualities for many business owners. 

Traditional lending is inherently more intensive throughout the approval process, with substantial paperwork and approvals that are more heavily based on sales histories. Securing financing through traditional lenders results in fixed loans that have much less flexibility when compared to an opportunity like PO funding.   

How Does Purchase Order Financing Work? 

Understanding how purchase order financing works is key. It’s actually a simple and clear-cut process, which is in part what makes it such an appealing option for so many consumer goods brands.

  1. You receive a purchase order
    When a customer wants to purchase from you, they use a purchase order to state what and how much of each product they’re ordering. The PO helps you determine whether or not you need additional funding to fill the order. If you decide that you don’t have enough cash on hand to order from your supplier, you may choose to use purchase order financing instead. 
  2. You place an order with supplier
    If you plan to use PO financing, you’ll connect with your supplier to request an invoice for the product(s) you’ll order. Once you have that in hand, you can begin the application process with a purchase order financing company
  3. Lender provides your supplier a letter of credit
    After you apply for financing, the lender will review your application and approve you for the amount you need (usually anywhere from 80% - 90% of the amount of the invoice your customer owes) so you can pay your supplier. They’ll send your supplier a letter of credit, stating that the funds will be paid. 
  4. Supplier sends the goods
    At this point, the supplier is sure of their compensation and they can fulfill the order. They’ll either send the product to you, or they may ship to your customer directly. Keep in mind, if you didn’t qualify for 100% financing, you’ll need to pay your supplier the difference.
  5. You invoice your client
    Once product is on the way, or if it’s been delivered to the customer, you’re at the point where you can invoice them.
  6. The invoice is financed and lender is repaid
    Payments from your customer will go to the purchase order financing company directly. They’ll reclaim their loan plus fees, and you’ll be forwarded any balance remaining. It’s easiest to think of financing fees for purchase order funding as a type of interest you’d pay for access to the cash.

 

Pros of PO Financing

Keep Growing: Keep business moving and your brand growing, as you never need to turn down potential sales due to inadequate capital. Preserves your reputation and allows you to grow.  

Easier Approval: Can be easier to get approved for (compared to some other more traditional types of funding options out there). Potential to use even if you have past credit issues, whether they be personal or business-related.  

Preserve Equity: With PO funding, you don’t need to sell off equity in your brand, making this a much-preferred option for those business owners not willing or hesitant to trade ownership for capital.

Option Even for New Brands: For companies just starting out, or for those who are considered “small,” even if they’ve been turned down or can’t qualify for traditional loans, PO funding may still be a viable alternative. 

Not a Loan: Can be a great potential solution if you need access to cash to pay suppliers, but don’t want to have to come up with years of monthly payments to repay a loan. 

 

Cons of PO Financing

Higher Cost: Costs to go through PO financing might be higher than some other types of funding options. This isn’t always true, but you should be sure you have a clear understanding of fees before you borrow. 

Customer Credit Issues: It may be more difficult to get approved if your customer has had credit issues in the past. Unfortunately, their bad credit can result in you not being able to secure PO funding. 

Time to Fund: While the approval process can be relatively quick, the actual time to see funds can be lengthy in some cases. It’s not uncommon to take weeks before PO lenders fund. 

Profit Margin Dip: While true anytime you borrow money, so it’s not unique to PO financing, it’s important to keep in mind that you’ll pay fees, which ultimately take from your profit margin. 

Perception: Your client or customer pays the PO financing company, not you. This may raise flags that you’re having cash flow problems

Who Uses PO Financing? 

While PO financing is a great option for some business types, it’s not for everyone. First and foremost, this type of financing is used most often for consumer goods brands. It’s not an effective means of financing for service-related companies. Wondering if it’s right for you? If the following describes your business and needs, PO financing could be the solution you’ve been looking for. 

  • You’re a startup or medium-sized brand
  • You’re B2B (Business to Business)  
  • You’re B2G (Business to Government)  
  • Your supplier has a long, positive, reputable history and a lucrative financial background
  • You have large purchase orders ($250,000+ is not unusual)
  • You (may) have a lower credit rating than what you’d likely need to qualify for more traditional loan options
  • Your customers have solid/good credit ratings
  • You don’t have guaranteed sale terms
  • You have tight cash flow and need to purchase materials/product to fulfill orders
  • You have heavily seasonal sales periods
  • You’re a growing company and have received outsized customer orders
  • You outsource
  • You’re a Reseller
  • You’re a Wholesaler

How to Qualify for Purchase Order Funding 

Fortunately, qualifying for purchase order financing is simple and straightforward. As long as you meet some or all of the following qualification requirements, you may be well on your way to securing financing. 

First and foremost, keep in mind that PO lenders aren’t as concerned with your credit history and your sales as they are with your customers’ credit history. Another important factor to consider is your supplier's reputation. Suppliers who are notoriously unreliable, late to ship or who don’t produce a superior product may hurt your chances of securing funding. A few other important factors that you should keep in mind:

  • You do not sell services, parts or raw materials, but you do sell finished products and goods
  • A typical PO would range, on average, at least $250,000
  • Your average profit margin of at least 20% - this is calculated by looking at the amount you charge for product compared to your supplier's costs
  • Your customers have inherently good credit and pay on time 
  • Your supplier, as noted previously, has a standing reputation both in terms of manufacturing and in delivering high-quality products, on time
  • Your financial statements are onhand and complete
  • You have POs from customers
  • You have invoices from suppliers

 How To Apply For Financing

Applying for purchase order financing with Assembled Brands is simple, quick and straightforward. We’ve made sure the process is as streamlined as possible, so you can secure funds and get back to work doing what you love, growing your business.

All you need to apply is:

  • The purchase order showing what a customer ordered
  • Your supplier’s information and their estimate
  • Your balance sheet
  • P&L statements

While not always required, you may also need:

  • Bank statements
  • Tax returns
  • Sales forecast for the next year

Want more information about how PO financing works, including an extensive purchase order financing definition and details to qualify?
Check out our Purchase Order Financing page today.