Financing your Big Sales with Purchase Order Funding
For many entrepreneurs and small business owners, getting a large purchase order from a prized client usually marks the end of a long road of hard work - and the start of a new road of opportunity. It provides owners the opportunity to take their companies to the next level of growth. But this only works if they have the financial resources to deliver the order.
This is where many entrepreneurs fall flat on their faces. They have the potential to get large orders but do not have the financial resources to deliver them. They often work with suppliers who demand an advance payment before producing and shipping the goods. And their sales are to corporate and government clients who demand 30 to 60 day payment terms. This leads to long payment cycles, where the business may take 90 to 120 days to recover its initial investment. It's easy to see why many small suppliers and resellers simply can't afford to grow.
Financing your purchase orders
One way to solve this problem is to use purchase order funding. It's important to note that this is not a loan against a purchase order. It's not a conventional funding solution. Rather, a finance company provides the funding to pay your supplier using your purchase order as collateral for the transaction. It bridges the gap in your finances and allows you to deliver the goods and book the revenue for the order. The transaction settles once your end customer pays the invoices for the goods.
This solution has a number of advantages over conventional business financing solutions. The most important one is that it enables you to take on and fulfil large orders that exceed your current financial capabilities. Also, qualifying for this type of solution is a lot easier than getting conventional financing. The most important requirements are to have a solid PO from a credit worthy customer, a reliable supplier and good profit margins.
The line is transactional, which means that you only use it when you need it. It can increase to match the size of your orders, as long as your transactions meet the funding criteria. These benefits are usually not available from conventional financing solutions. This makes po funding an ideal alternative for growing companies whose biggest limitation is lack of funds.
Most transactions follow a simple model, where the purchase order finance company covers your supplier expenses and settles the transaction when your client pays. Usually, transactions follow these steps:
- You get a purchase order from a credit worthy commercial client
- Transaction is reviewed by finance company
- Finance company pays your supplier - directly or though a letter of credit
- Your supplier delivers the goods
- After receipt, your client pays in 30 to 60 days
This links provides more details on the anatomy of a transaction.
Settlement and cost reduction
The transaction concludes once your client pays. However, you can usually close the po funding line once you submit an invoice to your client, by factoring the invoice. The advantage of combining both solutions is that it often leads to a lower transaction cost.
Limitations and disadvantages
Although this solution offers a number of advantages, it has some limitations and disadvantages. First, this type of financing is only available to companies that resell goods without any installation or modification. It has to be a strict product sale transaction. Second, due to the risk, the cost of po financing can be comparatively high. Purchase order financing rates go from 2% to 4% per 30 days of use. Because of this, it's suggested that it only be used on transactions that have high gross margins - 20% or above.
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