Purchase Order Financing vs Factoring: When To Use Each
Tricia has nearly two decades of experience in commercial and federal government lending. Her expertise is highlighted throughout small business loan content on Fit Small Business.
Andrew has over a decade of experience in finance and mortgage lending. He shares his expertise in Fit Small Business’s financing content.
This article is part of a larger series on Business Financing.
Purchase order (PO) financing and invoice factoring can both give you funding to manage cash flow shortages for your business. These short-term loans provide an advance payment based on your sales, but the differences between these two will determine which one you should use:
- PO financing is used when you need funding to pay for materials or services to produce tangible goods that haven’t yet been delivered to your customer.
- Invoice factoring is used when you have already delivered and completed a customer order but haven’t yet received payment from them.
PO Financing | Invoice Factoring | |
|---|---|---|
Typical Advance Rate | 100% | 95% |
Typical Funding Amount | $10,000 to $10 million | $20,000 to $5 million |
Repayment Term | Up to 90 days | Up to 90 days |
Estimated Fees | 1% to 4% per 30 days | 1% to 3% per 30 days |
Estimated APR | 20% to 80% | 20% to 70% |
Funding Speed | 2 to 21 days | 1 to 3 days |
See Our Recommended Providers |
When To Choose Purchase Order Financing or Factoring
The choice between PO financing or invoice factoring will depend on a variety of factors, such as the type of products you sell, your industry, and your company’s financing needs. Here are some tips on how you can determine which one you should choose.
PO financing and invoice factoring can both be expensive forms of credit. As an alternative, you should also consider our recommendations for the best working capital loans to help cover daily expenses like operational, rent, and payroll. Qualification requirements can be more difficult to meet, but you can usually get better rates.
Qualification Requirements: Purchase Order Financing vs Factoring
PO Financing | Invoice Factoring | |
|---|---|---|
Credit Score | None | None |
Time in Business | 0 to 12 months | 0 to 6 months |
Annual Revenue | None | $0 to $500,000 |
Profit Margin | 0% to 25% | None |
Qualifying Order Types | Orders involving tangible goods | Completed orders already sold and delivered to customers |
Eligible Customers | Manufacturers, distributors, wholesalers, and other types of suppliers | Business and government entities |
Contract Required | No | May be; 0 to 12 months |
How Purchase Order Financing Works
When you get funding from a PO financing provider, it’ll pay your suppliers on your behalf so that the goods can be produced and delivered to your customer. Your customer will then make payment to your PO financing company. Finally, the PO financing company will deduct its fees before issuing the remaining amount to your business:
- You receive a purchase order for tangible goods: PO financing typically requires you to have an order from a customer before applying for financing. This information is required because it’s used to determine your eligibility based on things like the type and cost of goods. Only orders involving tangible goods are eligible for PO financing.
- You obtain a cost estimate: When you provide the purchase order to your supplier, it’ll give you an estimate of what it may cost to fulfill the order. This can include expenses for shipping, distribution, delivery, and other production fees.
- You apply for PO financing: PO financing is available from several banks and online lenders. You can view our list of the best PO financing companies, all of which have competitive pricing, easy qualification requirements, and excellent customer service.
- Your application is approved and your supplier is paid: If your application is approved by the PO financing company, it’ll issue payment to your supplier. In most cases, payment is in the form of a letter of credit, so your supplier will be aware that you’re utilizing a third-party company for funding.
- Your supplier produces, assembles, or delivers your products: Depending on your agreement with the supplier, it’ll complete the production of the goods your business needs for your customer’s orders. Once the goods are produced or assembled, it’ll also usually handle delivery of the product to your customer.
- You invoice the customer and they pay the PO financing company: When your customer receives the product from the supplier, you can issue an invoice requesting payment. The amount of time it takes for your customer to pay can affect how much PO financing will cost you. The longer it takes, the more you’ll be charged.
- You receive payment from the PO financing company: When the PO financing is paid by your customer, it’ll deduct its fees and issue the remaining amount to your company.
You can read our guide on purchase order financing for more details and examples on how it works, where to get it, and what to look for in a financing company.
Pros & Cons of Purchase Order Financing
PO financing can be an expensive form of financing but, used properly, it can help your business grow and provide the funding needed to fulfill more orders.
| PROS | CONS |
|---|---|
| Easy qualification requirements, such as credit score and time in business | Most PO financing providers require a profit margin of 20% or more to qualify |
| Allows you to satisfy more customer orders | Certain types of orders can take several weeks to get approved and funded |
| Many PO financing companies can advance up to 100% of your order | Only tangible goods are eligible for financing |
How Invoice Factoring Works
When you’ve delivered a product or good to a customer, invoice financing can give you funding before that customer has paid you. Invoice factoring only works when your customers are other businesses or government entities. If you have unpaid invoices and need funding to address a cash flow issue, invoice factoring can be a good option to consider.
1. You invoice your customer for delivered products: Unlike PO financing, invoice factoring requires the product to be delivered to the customer. Your customer must also be invoiced for a factoring company to consider your application for financing.
2. You apply for and receive funding from an invoice factoring company: After you have delivered the product to your customer and issued an invoice requesting payment, you can apply for invoice factoring if you need payment more quickly. Eligible invoices typically are those that your customer must pay within 90 days, and your customer must also be deemed creditworthy by the factoring company.
Invoice factoring is available from many online lenders, brokers, and banks. Check out our roundup of the best factoring companies.
3. Your customer pays the factoring company: Part of the process of getting invoice factoring requires your customer to be notified that the collection of payment on the invoice has been assigned to a different company. Payment terms remain unchanged, but you may also want to communicate this with your customers so they’re made aware of this change.
4. You receive payment from the factoring company: The final step in the process occurs when the factoring company receives payment from your customer, deducts its fees, and issues the remaining balance to your business.
Our guide on how invoice factoring works contains information on the different types of factoring available, as well as how you can choose the best provider for your needs.
Pros & Cons of Factoring
Similar to PO financing, invoice factoring can be an expensive form of financing, so the benefits need to outweigh the costs to make it worthwhile. You should consider what you’ll gain by getting an advance payment on outstanding invoices and what you’ll be able to do with the extra funding.
| PROS | CONS |
|---|---|
| Fast funding speeds | Some providers may require a contract to factor for a minimum time frame, which can add to the cost of this type of financing |
| Easy to get approved as qualification requirements focus on your customer’s creditworthiness | Eligible customers are limited to other businesses and government entities |
| Typically does not require business owners to pledge collateral | Customers will be contacted by the factoring company |
Bottom Line
PO financing and invoice factoring can offer short-term financing to cover cash flow shortages for your business. Both can be an expensive form of financing, though, so to improve your chance of getting the best rate possible, you can view our guide on how to get a small business loan. This includes our recommendations for what to look for in a lender, as well as what paperwork you should prepare to ensure a faster funding speed.
