The Pros and Cons of PO Financing
Purchase order (PO) financing is a funding solution used by some businesses to get cash on hand without taking on a hefty loan. There are several advantages to this type of financing, especially for small and medium business owners.
When you’re in an order-based business, your clients generally expect that you’ll invoice them. The customer gets their work started or completed before paying the invoice in full.
Who Benefits Most From Using Purchase Orders?
Purchase orders aren’t used by every business. They’re sent out when the goods or services are ordered; whereas, an invoice is sent upon delivery.
Using purchase order invoicing is convenient for the client but not so much for a small or medium business owner.
Sure, it can boost your client load.
What happens when you need the working capital to get the jobs done, though?
This Catch-22 dilemma can be a serious one for businesses that rely heavily on invoicing.
If most of your income is tied up in invoices, how can you get the supplies and labor you need to fill your orders?
Purchase orders are a solid way to entice and retain customers, but you have to make them work for you. When your Accounts Receivable is full of unpaid invoices, it can drag your entire business down.
But if you have a large order or are going through a temporary lull, PO financing might be the solution to carry you through.
It’s crucial to weigh the pros and cons of this funding solution. This guide gives you a breakdown of why you should or shouldn’t turn to PO financing when you need cash fast.
What Is PO Financing?
Purchase order (PO) financing is a method used by businesses that need working capital to complete client orders.
This alternative funding solution is often confused with invoice factoring. The two do have similarities, but they’re not the same thing.
Both invoice factoring and PO financing can get a business owner working capital on hand fast. How much credit you’re able to obtain depends on your active invoices or open purchase orders.
Invoice Financing in Action
While you can only access the funds with invoice factoring after the work is completed, PO financing doesn’t limit you in that way. As long as your business sells tangible goods, you can get the supplies you need before making the sale complete.
For example, a medium-sized business sells coffee tables. They receive a bulk order for 1,000 tables, which will cost them $75 per table to make, including labor and materials.
The business owner doesn’t want to turn the order down but doesn’t have the credit line to access $75,000 upfront. Instead, the owner takes the purchase order, while in progress, to a PO financing company.
The company agrees to pay the supplier to manufacture the product and deliver it to the customer. Upon delivery and acceptance, the invoice financing company obtains payment from the customer. They deduct their fees and anything owed, then pay the business owner the rest.
If you’re looking to get your order filled, invoice financing is a good solution. But you don’t get the cash in your pocket to use as working capital. If that’s what you’re looking for, invoice factoring might be the way to go.
For further reading, check out our guides to Small Business Invoice Factoring and Spot Factoring
Advantages of PO Financing
If your business is approved for PO financing, there are some great benefits. The process is simple from start to finish, and you’ll get your money faster than a traditional bank loan.
Because they’re paying the supplier directly, you don’t have to deal with being the middleman in the transaction process. All you do is fill out the convenient application. You’ll find out if you’re approved fast, and funds typically make it to the supplier within 24 hours.
Unlike a traditional bank loan, there are no long-term payments. The fee comes directly out of the invoice, with no monthly repayment installments to deal with (or high-interest rates).
When the only thing stopping you from making a profit off a big order is paying for the materials, invoice financing can help.
What to Be Aware of With PO Financing
As with any outside funding solution, there are going to be some disadvantages to consider.
First, a PO financing company charges an upfront fee. The fee is usually a percentage of the purchase order. You’ll recoup the money when the client pays, but until then, it’s out of your pocket.
Once the financing company steps in, communication with the client is out of your hands. But there’s a risk there, too.
Dealing with an unknown company can upset your customers who don’t want their information shared with others. It can also give them the idea that your company is in trouble financially. Either way could drive current customers to seek other businesses for their needs instead.
Some financing companies also mitigate their risk by giving you part of the purchase order amount. You still have to come up with the rest of the funds to fill the order.
As a business owner, you already know that a non-payment is part of the risk you take when you invoice your client. When you sell an invoice to a factoring company, they usually take on that risk.
But when you’re working with a PO financing company, it can get messy. You may have to sign a guarantee of payment, even if the customer doesn’t pay.
It would be best only to use purchase order financing as a short-term solution when you need cash fast.
Speaking of needing cash fast, here’s What Your Business Can Do to Speed Up Invoice Payments.
Businesses That Use Purchase Order Financing
Some of the most common industries that turn to PO financing for their capital include manufacturing and distribution companies. As long as you provide a tangible good, though, your business can benefit from this type of funding.
The key to success with PO financing is to have clients who have proven their creditworthiness. When those clients make large orders during your slow season, financing their purchase gets you the inventory you need to do the job.
How to Get Approved for PO Financing
Guidelines for approval for most purchase order financing companies include:
- A pre-specified minimum gross profit margin has to be proven
- A successful track record of business transactions with similar companies/purchase orders in the past
- Legitimate, qualified customer orders
- A minimum transaction amount for your first purchase order financing amount
After approval, you follow the lending company’s instructions to submit the agreed-upon purchase order. They pay the supplier directly, and the supplier then delivers the product.
You send the customer their invoice as you normally would. The funder collects payment directly from the client. They deduct their fees and financing amount, then give you the rest.
It’s easier to get approved for purchase order financing because it’s through the client’s credit. That’s why a lot of startup companies find this type of financing to be beneficial. They can’t get approved for loans, but their cash flow stays clear with PO financing.
So if you’re concerned that you won’t get approved because of your business’s new or bad credit score, there’s less worry with this type of lending.
The funders focus on the credit history of the client, not you or your business. It’s the perfect solution for qualified startups and growing companies that have been open for less than three years.
Some PO finance companies also include debt collections as part of their service. Since they collect from the client directly, they may also deal with the non-payments. They have trained staff to execute professional, efficient debt collecting — leaving you free to do your job.
But purchase order financing doesn’t work for every company. If your goal is to cover your bills during a slow period, you need another funding alternative.
Alternatives to Purchase Order Financing
PO financing companies step in when traditional bank lenders won’t. They’re also an excellent interim choice when you need short-term solutions to fill an order. But not all businesses qualify for PO financing, and it’s not the answer to a cash flow problem.
So what do you do when you need working capital instead of a supplier paid?
Funding Solutions Instead of PO Financing
There’s always the business loan route, but that’s full of complicated paperwork and hoops you have to jump through. Getting approved can take weeks. By then, you’re even further in debt than when you started, and now you have a long-term bill every month.
Your hands aren’t tied, though. If PO financing doesn’t work for your business, one or all of these alternatives may:
Accelerated Invoicing
- Invoice accelerating solutions are a newer but cost-effective method of financing. Companies like Now step in to get you paid timely for the work you’ve already done.
- With accelerated invoicing, you deliver the goods or services to your customer. Instead of waiting for them to pay, which can be anywhere from weeks to months, your lending company takes over from there.
- The invoicing company agrees to “buy” your invoice once they research the client and deem them “creditworthy.” They then process it and pay you the amount you’re owed, minus their fee. There’s no repayment loan to deal with and no hefty interest rates. The customer pays the invoicing company directly.
- This is a popular solution with companies that sell to other businesses or governments. If your company sends invoices with net terms, accelerated invoicing could become a favorite financial solution when you need working capital.
Term Loans
- Repaying a loan for a short-term problem isn’t the best financial step, but sometimes it’s necessary. If you have to take out a term loan, make sure you’re comfortable with the requirements.
- With a term loan, you, as the borrower, get a lump sum amount of money. The funds repay in intervals for a specified time period. As long as you keep the repayment term short and the interest rate is low, you can pay the loan off in a timely fashion.
- The good thing about term loans is that you can use the money for anything your business needs to succeed. Whether you need working capital to cover overhead or you want to expand, the money is yours. However, interest rates usually start at 6% at a minimum for those with excellent business credit.
Lines of Credit
- Business lines of credit work similarly to a credit card. You’re given access to a certain amount of money for a specified time, and you only take out funds as you need them.
- You pay back the money as you borrow it, as you would a credit card. After the line of credit period is over, you no longer have access to the funds.
- This works well for small business owners who need to dip into a little extra cash reserve during slow periods. They then repay what they borrowed in full when they’re in peak season again. But, while you’re making the minimum payments, interest rates can be high on a line of credit.
The financing options that work best for your business depend on your unique needs and goals.
Are you okay with a long-term small monthly payment if it means you get a lot of cash upfront?
Would you prefer to avoid adding more bills and just use the invoices you’ve already generated?
Is purchase order funding enough to cover your distributors and get you through a big client’s request?
The answers to those questions will guide you to the funding alternative that suits your needs best.
Conclusion
Covering your business expenses is essential. But the funding options that take care of your needs aren’t a one-size-fits-all solution.
When you need the raw materials covered for a qualifying job, purchase order financing is one possible answer. Before you sign your PO away, make sure you know the pros and cons of what you’re getting into. There could be another alternative, with better payment terms, for your business.
Create your NowAccount to see if you qualify for accelerated invoice payments!
