Purchase order financing (PO financing) is an advance from a financing institution that pays your suppliers for goods you’re reselling or distributing to a customer who has completed a written purchase order. You can finance up to 100% of the purchase order costs with typical rates falling between 1.8% and 6% per month.
In this article, we’re going to discuss how PO financing works, when you might want to consider purchase order financing, and what the basic terms and qualification requirements typically are.
Purchase order financing typically takes 1-2 weeks to fund. If you need a solution quicker than that, you may want to consider a business line of credit from Kabbage. They can fund credit lines of up to $100K within 1 business day and you only pay interest on the portion of the line you use. Visit Kabbage today and you could be prequalified within 10 minutes.
What is Purchase Order Financing?
Purchase order financing helps businesses that need cash to fulfill product orders by paying your supplier for the manufacturing and transportation of goods up front, before you receive payment from your customers.The funds cannot be used for anything other than the purchase of specific goods needed to fulfill your customer’s order.
In order to qualify for purchase order financing you must sell finished goods (not raw materials or product components) to B2B or B2G customers with profit margins of 15%+. Startups can qualify, but the majority of your application depends on the creditworthiness of, and your past history with, your suppliers and customers. It can be easy to qualify for if your customer and supplier in the transaction are both well established and reputable companies.
PO financing is a great way to help your business grow without taking on bank debt or selling equity in your company. If sales outpace your incoming cash flow then purchase order financing might be a good fit to fulfill a new customer order.
Purchase order financing is funding you receive before you’ve delivered good to your customers, and before you’ve invoiced them. If you’ve already delivered goods or services to a B2B or B2G customer and invoiced that customer, invoice factoring is the right option, not PO financing.
Who Uses PO Financing & When?
There are many situations where purchase order financing might be right for your business. Each is centered around the need for cash to make purchases from suppliers that you can’t afford, but need in order to fulfill a customer’s order. Companies that use purchase order financing include:
- Importers or Exporters of Finished Goods
- Outsourced Manufacturers
Purchase order financing can help you with various scenarios that include:
- Seasonal Sales Spikes: At the beginning of a seasonal sales spike you may receive purchase orders that exceed your existing working capital.
- Substantial Growth: If your sales growth is outpacing existing small business lines of credit due to growth then you may be a good candidate for PO financing.
- Consistently Tight Cash Flow: Many small businesses have consistent cash flow problems at specific points of the month on a consistent basis.
This is not an all-inclusive list of when purchase order financing might work, but instead are some of the most common reasons it is chosen as a financing solution. Many of these scenarios can also be solved by using a small business line of credit through a loan provider like Kabbage.
A business LOC can be just as easy to qualify for as purchase order financing, but you can get funded quicker. Kabbage can prequalify you in minutes for up to $100K in financing and you can receive your funds as quick as 1 day.
How Does Purchase Order Financing Work?
Purchase order financing involves a minimum of four different parties who can complicate it at different points in the process. These parties are:
- The borrower: This is the one seeking financing.
- The PO financing company: This is the company providing the financing.
- The supplier: This is the company that supplies the goods which the borrower resells or distributes.
- The customer: This is the borrower’s customer who they sell to directly.
Each party involved can make it more difficult for you to complete the financing process, and can prevent you from keeping your costs down. For example, if your suppliers are slow to manufacture goods then you could be paying extra for the length of time it takes them to supply the goods. And if you’ve promised your customers terms on their payments then you could be looking at additional costs as well because the longer it takes for your financing company to be paid the more expensive your loan gets.
While all of this may seem confusing at first, it can easily be understood if you break it down step by step. Here are the 8 steps to purchase order financing:
Step 1: The borrower receives a large purchase order from their customer.
Step 2: The customer gets a written proposal from their supplier on what it would cost to purchase the goods necessary to fulfill the customer’s order. At this point, if the customer doesn’t have the available funds necessary to fulfill the order then they seek outside financing.
Step 3: The borrower finds the right PO financing company, applies for the funding they need, and gets approved. In order to apply you will need to provide both the customer’s purchase order and the supplier’s proposal.
Step 4: Once the borrower is approved, the PO financing company pays the supplier, through a letter of credit, to manufacture and deliver the goods needed to fulfill the purchase order.
Step 5: The supplier delivers the goods to the customer directly, or delivers them directly to the borrower if they have a different delivery method they prefer. Once the customer receives the goods they must accept the order.
Step 6: The borrower invoices their customer for the goods and either demands immediate payment or gives them net terms. The longer it takes to receive payment from the customer, the more expensive the financing becomes.
Step 7: The customer pays the PO financing company directly for the full price on the borrower’s invoice.
Step 8: The PO financing company deducts their fees from the funds and then pays the remaining balance to the borrower.
PO Financing Rates, Terms, & Qualifications
The table below represents typical terms and qualification requirements you’re likely to see from a purchase order financing company.
Purchase Order Financing Terms & Qualifications at a Glance
|Amount Financed||Up to 100% of the cost of goods to fulfill your customer purchase order|
|Time For Supplier to Be Paid||1-2 Weeks|
|Repayment Terms||60 Days or less|
|Cost||1.8% - 6% per month|
If you don’t qualify for purchase order financing, there are a number of other financing options that may better fit your needs.
General Terms of PO Financing
With purchase order financing you can fund up to 100% of the total cost of goods needed to fulfill a written customer order. Typically the application process is easy for the borrower. All you need to provide the financing company is a purchase order submitted by your customer and documentation of the costs you would owe your supplier to fulfill that order. The purchase order will need to detail a certain number of goods to be purchased and a specific price the customer is paying for those goods.
Each PO financing company will have their own minimum profit margin qualifications, but all start at 15% or more. You can expect the entire process to last about 1-2 weeks before your supplier is paid. Your supplier is paid through either a letter of credit guaranteeing payment for the goods (most common), or by a direct cash payment.
You should consider the time it will take your supplier to manufacture or provide the goods you need after they’ve received their payment. This could add to the timeframe in which your customer will receive the goods.
Purchase Order Financing Costs
Purchase order financing is an expensive short term funding solution. The fees vary based on the volume and risk of the transaction to the financing company. Most purchase order financing companies we’ve reviewed charge a percentage of the financed amount for the first 30 days in repayment. They then charge a different amount afterwards that varies on cost and the amount of days until it is charged again. The costs vary industry-wide from 1.8% to 6% per month.
The costs after the first month are not made as clear by individual financing companies, but the industry average for these additional costs are about 1.25% per week. According to Commercial Capital, a purchase order financing company, the following cost examples are common if you’re approved for a 3% financing rate:
|First 30 Days||After First 30 Days|
|Model 1||0.03||1% per 10 days|
|Model 2||0.03||0.1% per day|
|Model 3||2% for 20 days, then 1% per 10 days||1% per 10 days|
You’ll notice that all of these options have a similar cost for a 30 or 60 day term, but are broken up differently depending on when your customer pays. Obviously the quicker your customer pays your invoice (in most cases, after delivery or later) the less expensive purchase order financing becomes.
The loan term begins when your supplier is given the funds. This makes it a very expensive option if your supplier is slow to manufacture or deliver goods, or if you’ve promised your customer payment terms longer than 30 days. Both of these things can greatly impact how much PO financing will cost to your business.
The table below shows an example of what purchase order financing could cost you. We assume the loan in the table is paid by your customer in exactly 50 days, and that you qualified for a 3% interest rate.
Purchase Order Financing Cost Example
|1st Month Cost||$3,000 (3%)|
|2nd Month Cost||$2,000 (1% per 10 days)|
These costs are comparable to other alternative business loans, if paid back in the same time period. One example is a short term business loan which has a total APR as low as 30% for a term loan of up to 3 years.
Purchase Order Financing Qualifications
It’s pretty easy to qualify for purchase order financing as long as you deal with established, reputable customers and suppliers. Even newer businesses can qualify if you have verifiable industry experience.
The most important qualifications are that you’re a B2B or B2G business that sells tangible goods with a minimum of 15% profit margins. And that your supplier and customer involved in the transaction are creditworthy.
Profit margin is the one requirement that varies the most between financing companies. We’ve seen the minimum requirement as high as 25%, but typically it is set at 15% or 20%. The profit margins are calculated per transaction by using your customer’s written purchase order and your supplier’s written invoice.
The exact meaning of having creditworthy customers varies and depends on the loan provider you choose. Many loan providers will complete a commercial credit check of your customers through common credit bureaus like Dun and Bradstreet. At a minimum, your customers and suppliers should have the following credentials:
- Trend of timely payments
- No recent bankruptcies
- No serious litigation history
Where to Get Purchase Order Financing
There are not a lot of financing companies that only focus on purchase order financing, and also a limited number that we can find that even advertise it as a product. Many banks and financing companies that offer accounts receivable financing solutions may offer PO financing without openly advertising it. If you have a previous relationship with one of these institutions then we would recommend discussing what PO financing opportunities they might be able to offer you.
There are generally two types of financing institutions that offer purchase order financing:
- Banks: Traditional banks don’t commonly advertise PO financing, but many will offer it as an add-on financing for longstanding customers. If you have a previous positive banking relationship then you may want to start the process of finding a loan provider by checking with them first. It is likely that you would be able to get the best rate options for PO financing from a bank you have a previous financial relationship with.
- Loan Providers: There are other financing institutions that focus on AR financing or other lending solutions that will offer PO financing. These are primarily online lenders with varying rates.
If you would like to learn more about the top purchase order financing companies we’ve reviewed you can read our purchase order financing buyer’s guide.
What to Look For in a Purchase Order Financing Company
If you’re looking for the right PO financing partner then you’re going to want to know some specific details about the lender’s history in PO financing, and what their typical costs look like. To help you make the right loan provider decision, here are some questions you can ask potential providers before agreeing to work with them:
- How many transactions have they handled in your industry?
- How long have they been in business?
- What loan products do they offer? If PO financing is one of many products, do they have a team of specialists that exclusively work on purchase order lending?
- How do they pay suppliers and when? Is it through a letter of credit or through cash? Do they pay upfront or after the customer pays?
- What are their typical costs and what is the breakdown of those costs?
- What kind of background or credit check do they perform on your customers or suppliers?
- How do they receive payment from your customers?
- Do they have any communication directly with your customers?
The answers to these questions will give you a better idea of whether or not the product offered by any potential purchase order financing company will work with your business’s needs.
Purchase order financing is a good source of funding if your sales growth is outpacing your cash flow, but it can be expensive. It can help you take on additional customer orders while you wait to receive payment for past projects. For the best rates we suggest you have margins above 20% and have a long history with both your customers and suppliers.
We don’t recommend purchase order financing unless you’ve exhausted other financing options first. If you’re a prime borrower then you’ll have plenty of options available to you that will be cheaper than PO financing. An alternative solution, however, is obtaining a business line of credit from an online lender like Kabbage.
If you’ve been in business for at least 1 year, have at least $2,500 in revenue per month, and have a credit score of at least 550, then you may qualify for a business LOC of up to $100,000 with Kabbage. You can prequalify in minutes and be funded in as quick as 1 day.