Purchase order financing is a financial tool designed to provide working capital to businesses by advancing payments against the customer’s purchase order for finished goods. Small and midsize businesses which usually receive huge amounts of customer orders, but have relatively limited working capital, can tap into this financing recourse to grow their business and improve cash flow in the short-term. Under a PO financing arrangement, the lending company willingly accepts the added risk of guaranteeing that the supplier will complete the advanced order and then deliver the goods to the customer. If you compare PO financing with the more cost effective asset based borrowing, PO financing can also be lucrative, provided the company involved in the trade or transaction expects a healthy profit margin. A Purchase Order transaction can be undertaken by either a factor or a bank. It is also useful to compound Purchase order financing with the best factoring companies to diversify your options.
How purchase order financing works
Step 1: The PO financing process begins after you have received an order from a customer.
Step 2: During this step, you will submit the purchase order received from the customer to the financing company for endorsement. The submission will contain documents that indicate all the transaction cost.
Step 3: Once the order is approved, the financing company will make a direct payment to your vendors or suppliers in order to give them the green lights to commence the production of the said customer goods.
Step 4: The vendor or supplier then delivers the final product directly to your customer or through a third party affiliate or warehouse as necessitated in the agreement.
Step 5: During this stage, the business will invoice the shipment and submit the invoice together with a letter of credit from the customer to the bank or assigned factor.
Step 6: the bank or factor will then pay or fund the invoice at the supplier’s or arranging bank.
Step 7: the bank or factor will then move to collect the payments from the customer and pay your business the residual funds.
The benefits of using purchase order financing
- A business can receive cash advances of up to 100% of the confirmed cost of purchase.
- The financing company can negotiate the terms of the deal with the goods supplier or vendor on your behalf.
- Purchase order financing alleviates the trouble of going after your customers, to seek out payment. Financing companies can easily chase the payments because they have the appropriate credit and collection instruments to pursue customers.
- The funding received by a business can be used immediately to grow a business, improve cash flow or open new opportunities.
- The financing company offers you a direct line of contact to the financial world. You can also take advantage of this mutual relationship to get business insights and strengthen your financial security.
- The liaison between your business and the funding company can also help you maintain a good relationship with your customers and suppliers because payments and deadlines are met in good time.