The global supply chain took a massive hit during the Covid-19 pandemic, and its effects on organizations continue to this day.
From increasing consumer demand, to labor shortages and surging shipping costs, companies all around the world have to deal with multifaceted challenges. In fact, 75 percent of companies claim the supply chain disruptions have had negative or strongly negative impacts on their businesses.
Companies have the huge task of building resilience across their supply chain, and suppliers will need to show they can deliver orders.
In order to float and not sink in the current business environment, companies may need financing solutions to deliver purchase orders. Thus, when a company lacks liquidity, purchase order financing can help.
If you are a small business owner or a start-up looking for ways to finance a purchase order, this article will explain PO financing and its alternatives.
Let’s get to it.
The importance of purchase orders
First, every buyer sends a purchase order to their supplier to make an official order. If businesses didn’t use purchase orders, they would lack organization. They’d struggle to track their inventory, plan their shipping and delivery schedules, and wouldn’t have a good understanding of future orders.
Purchase orders outline all the essential information suppliers need, including the order description, PO number, quantity of items, pricing, and payment terms. Once accepted by the supplier, it’s a binding contract and must be fulfilled.
The common challenges companies face when they consider purchase order financing are:
- Not having the funds to pay a supplier to fulfill large orders.
- Lacking the inventory necessary and being unable to make a purchase.
- Lacking the required equipment to deliver an order.
- Not being able to wait to get paid by the customer and handle multiple orders in the meantime.
Since business operations must also continue and expenses must be paid, a company may resort to third-party funding. This is where purchase order financing comes in.
What is purchase order financing?
Purchase order financing, also known as ‘PO financing’, is essentially a PO funding solution for businesses.
PO funding or financing gives your company the ability to fulfill an order when you lack the liquidity to do it yourself. For example, if you are a business owner expecting multiple large orders or need to restock your inventory, you can use purchase order financing. You can apply for a purchase order loan for the entire cost of an order or just a part of it.
Companies apply for purchase order financing either with a bank or a purchase order financing company. It’s easier to get PO financing from the latter as banks have stringent processes and high credit score standards.
PO financing companies are more interested in your customers and their financial credibility as they will be the ones paying after you ship the order. Other considerations PO financing companies make include: the price of sale, if you have a production process, the gross margin on the transaction, your supplier’s credibility, and your financial position.
So how does purchase order financing work?
When your PO financing request is accepted, the PO financing company pays your suppliers directly to supply you with the materials/goods/services you need to fulfill an order.
Once your customer receives the goods, they will pay the PO financing company and you will receive your share after the PO financing company deducts their fees.
How does purchase order financing work?
If you apply for a traditional small-business loan, you will typically get a loan directly from the lender. Whereas, when you enter a purchase financing agreement, you’ll work with your supplier, your customer, and the purchase order financing company.
Say you supply electronic components, and you just received a large order from an industry giant. To fulfill that order, you need to pay your manufacturers, which you might not be able to do right away. So you finance it with a third-party (such as a purchase order financing company) to pay your supplier. Your customer will pay them, and the PO financing company will charge you their fees.
Let’s go step by step to understand how purchase order financing works in detail.
Step 1: You receive a purchase order
Your customer sends a purchase order through, and you determine if you can fulfill their order based on the number of goods required.
Step 2: You reach out to your supplier to confirm the costs
Your supplier sends you an invoice. At this stage, you’ll be able to confirm if you have the funds to buy the supplies you need.
Step 3: You apply for purchase order financing
Once you confirm that you can’t pay your supplier to fulfill your customer’s order, you should contact a purchase order financing company and submit an application. You will need to submit documents including:
- The PO of your customer
- Your supplier’s invoice
- The invoice for the PO
- Your PO to your supplier
- Business information (address, company number, etc.)
- Legal information (e.g. ongoing lawsuits)
- Financial statements
- Tax filings
Step 4: You get approved by the PO financing company
According to who your suppliers and customers are, the PO financing company may approve the entire funding or parts of it. The more well-established your customer is, the higher your chances are of receiving PO funding to cover the entirety of your costs.
Step 5: The PO financing company pays the supplier
After your purchase order financing application is approved, the PO financing company pays your supplier to deliver the goods to fulfill your customer’s purchase order.
Step 6: Your customer receives the goods
Your supplier sends the goods directly to your customer, who must approve the order.
Step 7: You send your invoice to the customer
Once your customer accepts the goods, you send your invoice to the customer as well as the purchase order financing company.
Step 8: The customer pays the PO financing company
Your customer will directly pay the PO financing company.
Step 9: The financing company will transfer your funds after deducting their fees
The purchase order financing company will deduct its fees and transfer you the remaining balance from the proceeds. Purchase order financing fees range from 1 percent to 6 percent per month and generally increase the longer it takes for your invoice to be paid.
What is local purchase order financing
A local purchase order (or LPO) is similar to a PO, but it specifies that the seller will provide the ordered goods to the buyer within the national or local boundaries. Some purchase order financing companies offer LPO financing at different rates.
What is the difference between factoring and purchase order financing
Purchase order financing is sometimes confused with invoice factoring or factoring, but the latter is based on orders you have already delivered.
Since 30 days is the standard payment term for most businesses, sometimes companies face gaps in their cash flow. Invoice factoring is a temporary solution for businesses that need immediate cash flow.
With factoring or invoice factoring, you work with a lender or a factoring company that purchases your outstanding invoices at a discount. You then get paid a portion of your unpaid invoices upfront.
So while purchase order financing allows you to buy goods from your suppliers to fulfill a confirmed PO, invoice factoring is a loan you get based on sales you’ve already made.
The invoice factoring company assumes responsibility for collecting the full amount of your invoices from your customers. They, however, charge a fee every week until your customers pay your invoice, which can be expensive.
Once the company collects the full repayment from your customers, they deduct a fee and send you the remaining balance.
A common disadvantage of both invoice factoring and purchase order financing is that your customer becomes aware of you working with lenders.
Alternatives to purchase order financing
As a business owner, you’re always looking for the best cost-effective funding and financing solutions. So let’s look at some of the options you should consider and compare them with purchase order financing.
Invoice financing
Invoice financing and invoice factoring sound very similar, but there are some key differences. While you sell your invoices to a lender for immediate cash with invoice factoring, invoice financing is a loan given to you according to the outstanding invoices you sent your customers.
You still have to collect payment for your outstanding invoices when you choose invoice financing. You can get a loan for up to 90 percent of the outstanding invoices, but you’ll have to pay the lender’s fees (usually a flat percentage of 1 percent to 5 percent of the invoice value). Invoice financing lets you keep your finances hush-hush.
Business lines of credit
A business line of credit is a flexible and continuous financing solution. It works like a credit card and gives your business access to funds (up to a limit) you need, and you pay interest on the amount you borrow.
However, you must ensure that you can make enough profit to pay off what you borrow to avoid running into financial troubles down the line. Ideally, you should be careful not to go beyond your credit limit.
Merchant cash advances
If your business processes a lot of credit card transactions each month, you can apply for merchant cash advances (MCA). With MCA, a lender gives you a cash advance in exchange for a fixed percentage on every card transaction, so you don’t have to worry about monthly installments.
However, merchant cash advances can be extremely expensive. For example, you might owe your lender 10 percent of all credit card sales until your debt is settled, and they debit your account daily.
Traditional term loans
A traditional term loan is a lump sum of capital you generally borrow from a bank with a repayment schedule and a fixed or floating interest rate.
Today, it’s more challenging to qualify for traditional term loans unless you already own an established business with a near-perfect credit score. In addition, the application process can be long and bureaucratic.
Funding and crowdfunding
Some companies can use crowdfunding to finance the production of a unique product or service with the help of independent investors and crowdfunding platforms. There is no guarantee that this type of funding can work. However, you will still receive the balance of collected funds, less the platform’s fees.
Outside investment
You can pitch your business or products to outside investors who can buy equity in your company or lend you money in the form of debt that has to be paid at a later date, with interest added.
Purchase orders are essential for a successful business
Navigating a teetering economy and fragile supply chains is a difficult task without optimized processes and organization.
If we traced the journey of a product from procurement to sales, a purchase order would always be the first essential document in the workflow. It’s also the first step in building your inventory and contains all the vital information you need to operate.
If a company’s destination is prosperity, a purchase order is the handiest road map a company can use.
Information on purchase orders helps you determine your profit margins, understand your costs, and anticipate trends so you can optimize your business operations.
Opting for digital transformation in your procurement process is necessary to analyze your and your customers’ purchase order history, so solutions such as purchase order financing become a last resort.
Good procurement software can make spend management and order management easy and save your business money while streamlining your procurement process.