Very few things excite business owners more than receiving large purchase orders. Unfortunately, the joy is often short-lived as reality sets in. How can you accept a large order when your bank account doesn’t have enough to cover supply costs?
PO financing and factoring are two common ways businesses unlock working capital in these situations. We’ll explore how each works independently and how the pair can be used together to help growing companies get ahead.
Purchase Order Financing vs. Factoring: What is the Difference?
Purchase order financing and factoring are trade finance options, a special type of financing option used to facilitate domestic and international trade. That means four entities will be involved: the seller of goods or services, their supplier, a final buyer or customer, and a third-party financing company.
Unlike other lending options, these solutions don’t necessarily rely on banks or load you down with long-term debt, so they can be a good resource when you want to grow by fulfilling a larger order but can’t due to the expenses involved.
Purchase Order Financing
Also known as purchase order funding, PO funding, or PO Financing, purchase order financing is all about getting the cash necessary for supply purchases. It’s like selling purchase orders (POs)—the documents given by buyers to sellers authorizing the purchase of products or services.
There are five main steps involved in purchase order financing.
- You receive a purchase order from your customer.
- You request an estimate from your supplier and submit it with your application to a PO financing company.
- Your PO financing company pays the supplier or provides them with a letter of credit.
- Your customer receives their order and their invoice.
- Your customer pays the financing company. The financing company collects their portion and then sends you the remaining money owed.
Purchase order financing companies will each have their own way of doing business. In some cases, your suppliers will receive cash. Other times, letters of credit may be used. This simply means that the financing company will guarantee payment to the supplier.
Sometimes a financing company will also circumvent you in the loop, which is somewhat common in manufacturing. In these cases, funders provide cash to suppliers, and the suppliers send the finished product straight to your customer. You’ll still receive a payment in the end, though.
It’s also worth noting that sometimes finance companies will cover the total cost of your purchase order, and other times they’ll only pay a portion, so you should be prepared to cover at least some of the cost of supplies. PO financing rates vary quite a bit depending on the amount of the PO, terms, and other considerations, but typically fall between two and six percent of the value of the PO each month the balance is outstanding.
Benefits of Purchase Order Financing
Often referred to as purchase order factoring, or simply PO financing, this form of financing stands out as a strategic tool for businesses. One of the primary benefits of PO financing is its ability to provide swift capital, especially when compared to traditional financing. Businesses that use purchase order financing can access funds even before an order is approved, ensuring they can fulfill an order without unnecessary delays.
PO financing works by allowing companies to use their purchase orders as collateral. This flexibility means that even if a business isn’t approved for PO financing initially, they might still have options like invoice factoring to help bridge their financial gaps. The synergy between purchase order financing and invoice factoring offers a comprehensive solution for businesses facing cash flow challenges.
Moreover, PO financing can provide businesses with the necessary funds to seize growth opportunities, especially when traditional forms of financing might not be accessible. It’s also worth noting that PO financing is typically easier to secure, making it an attractive choice for many enterprises. When PO financing is used in tandem with other financial tools, like invoice factoring, businesses can overcome various financial hurdles.
Invoice Factoring
Also known as accounts receivable factoring or accounts receivables financing, invoice factoring is all about accelerating payment after goods are delivered. Think of it as selling your outstanding invoices to a third party at a slight discount.
There are four main steps involved in invoice factoring.
- You receive a purchase order from a customer, deliver goods, and send an invoice.
- You provide your factoring company with a copy of the unpaid invoice.
- The factoring company gives you upfront cash—sometimes even on the same day. You’ll typically receive somewhere between 60 and 80 percent of the value of the invoice to start, though some companies will advance as much as 100 percent under certain circumstances.
- Your customer pays the factoring company. The factoring company then sends you any remaining cash due, minus a nominal factoring fee.
There are both recourse and non-recourse factors, meaning sometimes you’ll be responsible for paying back the factoring company if your customer doesn’t pay, and other times the factoring company accepts responsibility for non-paying clients. In any case, non-payment is rare because factors typically perform credit checks on your customers before accepting invoices and will let you know how creditworthy each client is.
Factoring fees will vary based on several considerations, such as the number of transactions you do with your factoring company, the value of the invoice, and invoicing terms, but will usually land somewhere between one and five percent of an invoice’s value.
Benefits of Invoice Factoring
Invoice factoring offers several advantages to businesses. By selling unpaid invoices to a factoring company, businesses can quickly receive payments, improving their cash flow. This method is beneficial for businesses of all sizes facing cash flow challenges or seeking funds for expansion. Notably, invoice factoring is available even to those with imperfect credit histories. Unlike traditional bank loans, it doesn’t require collateral or personal guarantees, making it a preferable option. It provides immediate cash without adding debt, and the factoring company handles invoice collection, saving businesses time and effort. Overall, invoice factoring is a strategic choice for maintaining steady cash flow and improving working capital.
Companies That Use Purchase Order Financing and Invoice Factoring
- Distributors
- Wholesalers
- Resellers
- Importers and Exporters of Finished Goods
- Outsourced Manufacturers/ Manufacturing Facilities
Qualification Requirements
Qualifying for PO financing and factoring is more about the strength of your customers and suppliers than your personal or business credit. That’s because the inventory or invoices are considered assets, which serve as collateral for you, and any debt involved is expected to be paid by your customer.
With that in mind, your supplier and customer should:
- Be creditworthy.
- Be a viable business customer or government entity.
- Have a profit margin of at least 15 percent.
One of the benefits of invoice factoring, especially for small businesses or business owners with bad credit, is that neither your personal credit score nor that of your customers is taken into consideration when a factor in determining whether you qualify. Because the invoice factoring company provides you with an upfront cash flow and collects on the unpaid invoices, they are more concerned with your client’s credit histories than yours.
Combining Factoring with PO Financing
PO financing and factoring can each help your business thrive in its own right but pairing them together has unique benefits.
There are seven main steps involved when you pair PO financing with factoring.
- Your customer sends you a purchase order.
- You connect with your supplier and get an estimate for the cost of goods to fulfill the order, then give the estimate to your PO financing company.
- The PO financing company pays the supplier, and the supplier sends you raw goods.
- You fulfill your customer’s order and send them an invoice.
- You provide your factoring company with a copy of the invoice.
- The factoring company pays your PO financing company and may send you upfront cash too.
- When your customer pays the invoice factoring company, the factor pays you any remaining cash, minus a small factoring fee.
By going this route, your company accelerates cash flow and can pay less in interest fees to PO financing companies too.
How Can Factoring and PO Financing Help Your Business Grow?
Now that you know the basics of factoring and PO financing and the process of using them together, let’s take a look at some of the key benefits of this strategy.
1. You Can Take on Larger Orders
If you can’t afford to take on an order or want to be able to accept larger orders than you can now, factoring and PO financing are paths that can help you level up.
2. Funding is Easier to Get Than a Traditional Bank Loan
Traditional bank loans have all kinds of criteria businesses need to meet to qualify for financing. Because of this, most small businesses don’t get the level of funding they need through traditional business loans. PO financing and factoring don’t work the same way. Again, it’s more about having strong customers and suppliers, and most businesses will usually qualify if they have them.
3. Deployment is Fast
It can take weeks or months to close on a traditional bank loan. If you’re relying on one to fulfill an order, there’s a good chance your customer won’t be willing to wait, and you’ll lose out on the business. Because trade credit is specialized funding designed specifically for these types of situations, funding is incredibly fast and sometimes happens on the day you submit documentation to your PO funding or factoring company.
Take Your Business to the Next Level with PO Financing and Factoring
If you’re ready to scale your business with factoring, Charter Capital can help. It doesn’t cost a thing to become established and find out your rate, so you can get set up now and be ready to take action the next time a large order heads your way. Request a complimentary rate quote now.
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