What Is Purchase Order Financing and How Can It Help Your Business Grow?

Sometimes, businesses don’t have the upfront capital to fulfill major customer orders that go beyond what they’ve done in the past. Traditional business financing options may take too long, causing production and order delays. When this happened, purchase order financing can be a valuable solution.

In this article:

• How purchase order funding can provide the immediate business funding you need to meet a major order.
• How purchase order funding for small businesses works, and the key advantages for businesses.
• Understanding the application process and comparing to other business loans.

What is Purchase Order Financing?

Purchase order financing is a short-term financing solution in which a purchase order financing company provides a business capital to meet the production demands for an order made by a creditworthy customer. It’s essentially a bridge loan designed to cover the cost of fulfilling a confirmed order. Unlike traditional loans, in which lenders evaluate your business’s credit score and history, with purchase order funding, a financier looks at the strength of your customer’s purchase order instead.

For example, if your business closes a major contract for 10,000 units of your newest product, it’s a big deal. But your manufacturer requires a 50% deposit upfront for such a larger order, and you don’t have the working capital to cover that. Rather than lose the order, purchase order financing allows you to get a cash advance from a PO financing company to pay your supplier so you can capitalize on the opportunity.

How Does Purchase Order Funding Work?

The process of purchase order funding is typically straightforward and designed to be efficient to meet the time-sensitive nature of fulfilling orders. Here’s how purchase order financing works:

1. You receive a confirmed purchase order: A legitimate, non-cancellable purchase order from a creditworthy customer starts the whole process. A PO funding company will evaluate your customer’s creditworthiness rather than yours, so the stronger their credit history, the more likely it is that you’ll get approved for funding.
2. You apply for purchase order financing: When you have a confirmed purchase order, you bring it to a purchase order funding company for evaluation. They’ll do their due diligence to ensure the legitimacy of the order and reliability of your supplier.
3. Funds are advanced to your supplier: If approved, the purchase order finance company directly pays your supplier for the cost of the goods. They get to work without you ever actually handling the funds.
4. Fulfill the order: Your supplier ships the goods directly to your customer per the purchase order terms.
5. Your customer pays the finance company: Once they receive and accept the goods, they pay the full invoice amount directly to the purchase order finance company.
6. You receive the remaining balance: The purchase order finance company deducts its fees and the original advanced amount, and then remits the remaining balance to you. That’s your profit margin. This represents your profit margin on the order.

The whole process should be fairly seamless when you’re working with a reputable company. The PO funding process allows you to fulfill large orders without tying up your working capital, so you can take on larger order than your current cash flow allows.

Advantages of Purchase Order Financing

Purchase order funding may have several compelling advantages for businesses that are looking to grow.

• Debt-free capital: Unlike traditional loans, purchase order funding won’t put your company in debt. Rather than taking on a loan that has to be repaid based on interest rates, like a term loan or business line of credit, purchase order financing is a transaction-specific solution. As soon as the transaction is completed, you’ll have paid off the borrowed amount.
• Accelerated growth: Purchase order funding empowers you to fulfill large orders that would otherwise be out of reach. That can set small business owners up to start growing their businesses much faster.
• Improve supplier relationships: Suppliers always want to be paid promptly. Large orders may make that more difficult to do. However, purchase order funding can ensure your suppliers receive on-time payments, which can fortify the relationship and potentially lead to better terms and discounts.
• Bridge cash flow gaps: Even profitable businesses can experience cash flow challenges, especially when dealing with long payment cycles from customers. Purchase order funding can help bridge a gap when you’re waiting for customer payments.
• Fast approval process: Traditional bank loans often have long approval processes and require extensive documentation, like financial statements and tax returns. Purchase order financing has lower eligibility requirements and can often provide funding much faster than business loans.

When Should Your Business Use Purchase Order Funding?

Purchase order financing has advantages and can be a great lifeline for growing businesses. However, it also frequently comes with significant financing fees that cut into your profit margin and may be more expensive in the short term than other small business loans. It’s not always the ideal solution, but it might be right for:

• Wholesalers, distributors, and resellers: Businesses that purchase finished goods from suppliers and then resell them to customers are excellent candidates for purchase order funding. This could also include importers.
• Businesses with major orders: When you get a major, non-cancellable purchase order from a creditworthy customer that you don’t have the upfront capital to fulfill, purchase order financing may be tailor-made for you.
• Businesses short on working capital: Rapid growth can lead to cash flow crunches that make it difficult to meet supplier costs, especially if you have to pay them upfront. In this case, purchase order funding can provide additional liquidity.

On the other hand, businesses that manufacture goods from raw materials or are in the service industry may have less use of purchase order loans since their accounts receivable isn’t based on orders that have to be manufactured or fulfilled by a third party.

Key Considerations of Purchase Order Funding

If you feel that purchase order funding is the right financing solution for your business, it’s imperative to find the right PO financing company. Here are some of the most important considerations when you look:

• Experience and reputation: Companies with a proven track record and positive reviews can provide the necessary experience to navigate deals quickly and without confusion.
• Fees and transparency: Less reputable PO financing companies may try to complicate deals with confusing terms and hidden fees. Make sure you understand the fee structure and agreement quickly to know exactly what you’re getting and paying.
• Flexibility: Some businesses need more tailored solutions than others. Companies that can accommodate specific requests may be easier to work with in the future.
• Industry specialization: Some purchase order funding companies specialize in specific industries. If they have experience in your sector, they may better understand your unique challenges and opportunities.

Final Thoughts

When you get a large order that you can’t immediately fulfill, it’s a bit of a chicken-and-egg situation. You need the order to grow, but you don’t have the ready capital to do so. Purchase order financing can help your business fulfill larger contracts and accelerate your growth. You can leapfrog off the back of a single major order to expand product lines, hire more staff, and expand into more markets.

The lack of upfront cash doesn’t have to hinder your organization’s ability to reach the next level. Purchase order funding may be an excellent way to capitalize on growth opportunities. Just remember to review the terms and purchase order financing cost to understand exactly what you’re getting into.

FAQs About Purchase Order Funding

Is purchase order funding a loan?

No purchase order financing isn’t a traditional loan. It’s a type of financing solution that essentially allows a third party to buy a purchase order from your customer. They advance funds to the supplier to produce and fulfill the order, and then collect payment directly from the customer. Then, they pay you the remaining balance. There isn’t any debt involved.

What types of businesses are best suited for purchase order funding?

PO funding is best for businesses that buy finished goods from suppliers rather than manufacturing goods themselves or providing services. This often includes wholesalers, distributors, resellers, and importers.

What are the main benefits of using purchase order funding for a startup?

Many startups struggle to qualify for traditional business loans and, even if they do, may have a difficult time dealing with debt so early in their journey. Purchase order funding can help accelerate growth without diluting your equity in the company or saddling your business with debt. Plus, it tends to have a faster approval process than traditional loans.

How quickly can I get approved for purchase order funding?

It depends on the order and the purchase order financing company. That’s much shorter than the several weeks that business loans with traditional banks often take.

What are the typical costs associated with purchase order financing?

The main cost of purchase order financing is the discount fee, which is the amount the purchase order financing company charges for the cash advance and fulfilling the order. This fee may range based on the order size, your customer's creditworthiness, and how long funds are outstanding. Make sure to review the terms to understand any costs.

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