Purchase Order Financing, or PO Financing, is a type of commercial financing that leverages the purchase order from your customer as collateral for the loan.
What Is PO Financing?
Purchase Order Financing offers you cash before the work starts, which makes it an attractive option for manufacturers with tight cash flow. PO financing is based on your purchase order, your customer’s credit, and your supplier’s reputation. A lender will charge an interest rate on the advance, usually somewhere between 1 to 6 percent per month.
How does PO Financing Work?
Funds from Purchase Order financing do not go into your company’s bank account. The money is sent directly to your suppliers. This ensures the money is only used for the materials or supplies needed to perform the work on the purchase order. After the work is complete, you’ll send an invoice to your customer like normal, but the customer will pay the lender directly. Once payment is received, the lender will repay the borrowed amount, plus any fees or interest due, and forward the remainder to you.
For example, let’s say ABC Manufacturing produces heavy-duty, preservative-treated wood for utility poles, marine pilings, and agricultural structural posts. ABC owner Lee gets an order to provide the pilings for a new marina. The purchase order is worth $750,000—a huge opportunity for her company—but, she doesn’t have the capital to order all of the necessary supplies. She works with a PO financing company to secure a loan of $245,000, which allows her to pay her suppliers and fulfill the customer order. After she submits her final invoice, the customer pays back Lee’s lender, and Lee is sent the remainder. The PO financing allowed her to take on a larger order than before, fulfill the order on-time, and STILL make a profit. This additional profit streamlines ABC Manufacturing’s cash flow, allowing her to start the next job without a cash flow crunch.
The Risks and Benefits of Purchase Order Financing
One of the greatest benefits for business owners is that Purchase Order financing starts before the job. It’s definitely less risky than Merchant Cash Advances, which promise fast cash but too often end up delivering a crushing cycle of debt.
On the other hand, PO financing relies on the credit of your supplier and your customer, rather than on you and the job’s contract. Many Purchase Order financing companies also ask that the business expect at least 30% profit margin from the total order. That might not give you pause, but how certain are you of your numbers?
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Is PO Financing Right for Your Company?
Purchase Order financing can help you free up cash before a job starts, but is it the BEST option for your manufacturing company? The short answer, of course, is: It depends. Do you already have an existing line of credit with your supplier? Don’t borrow money from a third source when you can get the materials you need on credit straight from the supplier. Instead, borrow for the things you can’t get on credit.
PO financing from a reputable lender, like us, empowers you to start work confidently. Without this financing option, you could miss out on new customers and larger orders that ultimately will help your business grow.