What is Purchase Order Financing?
When we talk about purchase order financing, here are some of the parties involved and how you’ll see us refer to them:
- Seller: That’s you
- Purchase order financing company — the funding partner you’ll use that supplies the funding
- Supplier: The manufacturer/supplier that produces your product
- Customer: The retailer or other reseller purchasing your product to then sell to their customers
Purchase order financing enables you (the business) to receive immediate funding to help you cover the costs of producing the inventory covered by a retailer’s purchase order, where you exchange the future, full payment value of the purchase order for an immediate payment at a discount on the full value, often referred to as the “discount.”.
For growing brands, a purchase order represents the potential to enter into wholesale relationships that can increase distribution, awareness, revenue and profit, but a growing company may not have the up-front capital to produce the order’s inventory or it may deplete the company’s cash reserves and cause a significant risk to the ability to cover other operating costs while waiting on the payment terms from the retailer — sometimes as long as two or three months after delivery.
You need funding to produce the inventory so you don’t miss out on the growth opportunity. That’s where purchase order funding comes in so you don’t miss out on a big order that can potentially change your brand’s trajectory.
Sometimes purchase order financing covers the whole order, or just a part of it. In many cases, purchase order financing companies will collect payment for the order directly from the retailer that issued the PO, subtract their fees (the “discount”), and then give the rest of the money to you.
In short, the company that funds your purchase order essentially purchases the purchase order from you for a discounted rate. When it comes to purchase order financing rates, the discount exists for a few reasons:
- This is the cost of their product. Imagine it like this: You’re buying immediate cash on a PO that would otherwise take you months to collect on but you want or need the money now.
- In addition to the fee for their service, the company buying your purchase order from you takes on all the risk of receiving payment from the retailer that will receive your product. Even the biggest, seemingly safest retailers can experience circumstances that prevent making payment to all their creditors (think of companies that Toys ‘R’ Us, now bankrupt, owed money to)
What is PO finance?
PO financing is another term for purchase order financing. You’ll see these terms used interchangeably.
What is purchase order factoring?
Similar to PO financing, purchase order factoring is another term for purchase order financing. Often the company purchasing the PO from you is called a “factor.”
How does purchase order financing work?
When a small business is first starting out, one of the biggest issues they may face is cash flow problems. With the launch of a new product or a new website, you may be ill-prepared for strong and sudden demand. You may find that you have sold through most of your inventory and you need to re-up as soon as possible. The only problem is that you do not have enough cash on hand to make a full inventory purchase. This is where purchase order financing can become extremely helpful. Essentially, purchase order financing is a way for businesses to secure the funding they need to buy the inventory needed to complete customer orders. By working with a purchase order financing company, a business can have the PO finance company pay a supplier to manufacture and deliver the goods directly to the customer. The customer then pays the PO company who then takes their initial investment plus any fees and returns the rest of the money from the sale to the business. This makes sure everyone is paid and that the customer does not need to be denied an order. Here is a list that breaks down how purchase order financing works in the simplest steps.
- Receive PO: Customer sends you a purchase order detailing the goods they would like to purchase as well as the quantities. If you are unable to fill the whole order and lack the working capital necessary to complete a new inventory purchase, then purchase order financing is available to you and your business.
- Supplier prepares a quote: Ask your supplier to prepare a quote for how much it would cost to replenish the inventory you need to fill your customer’s order.
- Apply for PO financing: With your customer PO and supplier quote in hand, you can apply for PO financing through a PO finance company. Depending on you and your customer’s creditworthiness, they could agree to finance either 80%, 90%, or 100% of the inventory purchase from the supplier.
- Supplier delivers goods: Most often the supplier will deliver the goods directly to the customer.
- Invoice customer: Invoice your customer for the total amount of the sale.
- Customer submits payment: The customer then is required to pay the invoice directly to the PO financing company rather than to your business.
- Interest is deducted from the total amount: Once the PO financing company has been paid by the customer, they will deduct their fees from the total amount and forward the rest of the money back to your business.
Purchase order financing is a pretty straightforward process and it can be a useful tool to many small businesses who are just starting out and may lack the cash flow to make large inventory purchases to fulfill all customer orders.
Pros & Cons of Purchase Order Financing
Purchase order financing can be the perfect solution to fulfilling new or larger orders than anticipated. In fact, it exists exactly for this reason and because so many companies find themselves in this position. As with any new source of capital, it does have its pros and cons. Let’s take a closer look at them so you can decide if purchase order financing for small businesses is right for yours.
Pros of purchase order financing
- You’re able to take on a client or order you wouldn’t otherwise have been able to
- It’s not a loan, so you don’t have to plan out repayments (your customer pays the finance partner, which then deducts their costs and forwards the remaining balance to you)
- Once you’ve established a relationship with a purchase order financing lender, many businesses report being able to quickly and easily work with them again in the future
- Should your customer not pay, because your purchase order financing lender is the first to be owed money, it will pursue payment, adding strength to your efforts
- Having bad credit won’t necessarily prevent accessing funding since the creditworthiness of your customer is the primary concern
Cons of purchase order financing
- Your lender will take a percentage of the entire purchase order, which eats into your profit from the order
- Fees often range between 1.8% – 6% per month, which can become quite significant if your margins are relatively tight
- Your choice of funding partner can reflect on you. The relationship developed between your customer and your financier could impact the relationship you develop with your customer.
- To qualify, the order total often needs to be substantial ($50,000 or more, typically)
Purchase order financing for small businesses can be the perfect answer to seizing growth opportunities regardless of how much cash you have on hand and can help grow your business fast, but stay educated about how, when and if they’ll work for you. Make sure to review your timelines, when you can expect payments and how financing can impact your margins. In the right circumstances, purchase order funding can help your brand accelerate growth in a way unlike many other financing options available.
Purchase Order Financing Examples
To help you understand, let’s have a look at an example of purchase order financing.
You’re a wholesaler of pet supplies and you get a call from the biggest pet store chain in your state. They’ve been let down by their supplier, and they’re wondering if you can fulfil their needs. You can, and you want to, but the order is the largest you’ve ever had and the cost to produce that amount of inventory is more than you have available. You don’t want to miss out on this opportunity but you know you can’t afford it alone, so you reach out to a purchase order funding provider.
Who Uses Purchase Order Financing?
Purchase order financing is used by a wide range of businesses, such as:
- Any business selling a physical product that can be ordered to be sold by another retailer (wholesale orders)
- Importers and exporters
- And generally:
- Any of the above experiencing tight cash flow
- Businesses growing more quickly than cash coming in
- Businesses heavily reliant on seasonal sales that need to order larger inventory runs during their slower cash months
Who can’t or shouldn’t use purchase order financing?
Generally, you PO financing won’t be available to your business if:
- You’re a service provider
- You’re a manufacturer
- You sell raw materials
Who sends a purchase order?
A purchase order comes to you from a customer intending to purchase your products and then resell them in their own store or marketplace (a retailer like Target, for example). When financing a purchase order, (in most cases), you’ll send your funding partner a copy of the supplier’s estimate and then they pay that supplier to produce the inventory for the order. The supplier will then ship the finished goods to your customer.
What is Local Purchase Order Financing?
Local purchase order financing is essentially the same thing as normal purchase order financing. The only difference is that – unsurprisingly – it focuses on local financing. Typically, this means that they will only lend on orders within the same country, though it can be a smaller territory.
Purchase Order Financing Rates
The amount that you can borrow using purchase order financing depends on the size of your purchase order and the creditworthiness of both you and your customer. If you and your customer qualify, then the PO finance company could fund up to 100% of the inventory purchase from the supplier. Typical rates can range anywhere from 1.15% to 6% per month. The PO finance company will deduct those fees once they receive payment from the customer. After the fees have been deducted, the remainder of the money will go back to your business.
What type of businesses is purchase order financing best suited for?
Purchase order financing can work for any type of business that may lack the funds necessary to acquire the inventory necessary to fulfill a customer’s full order. However, some of the most common types of businesses that utilize purchase order financing are the following.
- Business owners with bad credit
- Importers or exporters of finished goods.
- Outsourced manufacturers.
- Government contractors fulfilling large government orders.
Are there alternatives to purchase order financing?
Yes, there are a few different alternatives to purchase order financing. The main alternatives include short-term business loans or bridge loans, invoice factoring, and a business credit card.
Where can I get purchase order financing for my small business?
There are plenty of purchase order financing companies out there for any business owner to choose from. Some may be better for different situations. For example, King Trade Capital typically only works with larger businesses whereas SMB Compass has a great reputation for working with small business owners in a variety of industries. Here are the top five most recommended purchase order financing companies for business owners in 2022.
- SMB Compass
- King Trade Capital
- Liquid Capital
- 1st Commercial Credit
Different purchase order financing companies are known for and best for certain types and sizes of companies. You may want to do some research on different companies before committing. If you have any doubts, you may want to check out some reviews online or ask other business owners their opinions.
How much does purchase order financing cost?
Typical rates that purchase order financing companies charge for their services can range from as low as 1.25% to as high as 6%. Interest is charged on a monthly basis and most purchase order finance companies expect payment within the first 90-days.
What kind of things should I look for when applying for purchase order financing?
Before committing to a purchase order financing company, you should look at how much they charge for their services, what other terms and conditions they may have for their services, and if they have any reviews or any evidence of an established reputation in the business world.
Purchase Order Financing – Alternative Options vs. Using a Traditional Lender
As we have learned, purchase order financing allows businesses to pay suppliers without interrupting cash flow. PO financing can provide the funds a business needs to purchase inventory. Securing purchase order financing through a traditional lender can be expensive and funding times can be long. The complications often send business owners in search of an alternative.
On Kickfurther, you can purchase inventory on consignment. The Kickfurther inventory funding platform can help you get the funding you need cheaper and faster. With an average funding of $78,000 and funding capability up to $1MM, you can get the funds you need to manufacture new inventory or get reimbursed for current stock. When you compare our rates to other forms of funding, you’ll often see you’re saving. In addition, returning companies can see their rates fall each time they use Kickfurther.
Get funded with Kickfurther inventory financing
Kickfurther is one of the lowest cost online inventory funding platforms available. Created by an entrepreneur that once struggled to find affordable inventory funding, Kickfurther is designed for entrepreneurs.
Discover unlimited funding for one cost at Kickfurther and funding options up to 30% cheaper than similar options. In addition to lower costs, you can enjoy flexible repayment schedules that allow you to sell more inventory now and pay later. Marketplace participants can provide funding for inventory. Funding then goes directly to the manufacturer. As a seller you make no payments until you receive and begin selling new inventory.
Produce & sell more inventory. . . apply for inventory funding on Kickfurther today!
How to Apply and Qualify For Purchase Order Financing
It’s not complicated to apply for purchase order financing, but it can be time-consuming the first time you look for a lender to work with. The good news about purchase order financing is that once you find a solution you like working with, they can become a reliable partner as you grow.
You need to do your due diligence when you search for a purchase order lender, as you should when you look for any type of financing. Search online or ask friends for recommendations and check financing companies’ requirements before you consider applying.
Once you find one you’d like to work with, prepare a few documents they’ll see. These are:
- Your customer’s purchase order
- Your supplier’s estimate or invoice
- Your invoice to your customer
- Your purchase order you submitted to your supplier
- Financial and tax statements, such as your profit and loss statement
You’ll also need any relevant business and legal information.
All lenders have different requirements, but there are a few things you’ll often find as common requirements that you can use as a benchmark:
- Your sales typically need to be over $50,000
- The gross margin needs to be 20% or more
- Your customer also must be creditworthy, because your ability to get PO financing is actually based on them (remember, their ability to pay for the delivered order is chiefly important)
- It must be impossible to cancel the order
- You need to be in good financial standing