What is Purchase Order Financing?

You’re on the hook for inventory and materials, but your invoices are still outstanding. And your business has to make payroll next week, and rent is due the week after. Then an order comes in, the biggest one you’ve landed yet—and all of a sudden, you’re wondering if your business can fulfill it. What do you do?

Purchase order financing can be the answer you’re looking for to keep things running smoothly. Through purchase order financing, you can secure the cash to fulfill your commitments and pay for inventory and supplies, all before you ever receive payment from a customer. This article will explain what purchase order financing is and how your business can benefit from it. 

What is purchase order financing?

Purchase order financing is a type of short-term financing that can help your business pay for the inventory, materials, or services to fulfill incoming customer orders. Purchase order financing can help your business land sales or new accounts that you might not otherwise have the funding to service. Purchase order financing can benefit new businesses as well as established companies that are rapidly growing or facing a working capital shortage for any number of reasons.  

How does purchase order financing work?

There are four parties in purchase order financing: the financing company, the client, the supplier, and the customer. Here is how the parties work together in traditional purchase order financing agreements: 
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• ​Borrower. The borrower is the business that requires funding in order to fulfill customer orders that have already been placed. The borrower enters into an agreement with the financing company.
• Lender. The lender is the purchase order financing company. First, the lender will confirm the details of outstanding purchase orders and then send funds directly to the supplier for inventory or materials. 
• ​Supplier. The supplier provides the finished goods inventory to be delivered to the customer, as it is ordered. 
• Customer. The customer is the borrower’s customer, who placed the order for goods or services. In a purchase order financing agreement, the customer will receive the finished goods or services and directly pay the lender. 

When to use purchase order financing

Wondering whether to use purchase order financing? Common scenarios in which many business owners opt to use this financing option include: 

• Acquiring new customers
• Expanding a geographic footprint
• Entering a new market
• Navigating a period of rapid growth
• Riding a seasonal or short-term spike in demand
• Reducing a cash flow crunch

Qualifying for purchase order financing

The purchase order financing approval process is often fast, with approval in days to up to two weeks. It depends on how quickly purchase order details can be provided and confirmed and is contingent upon meeting other requirements of the lender. 

In general, you will need to provide the lender information about your business, the customers involved, and your company’s financial history. In addition, approval for purchase order financing may hinge on how much of a credit risk your customers pose, not your business. Lenders will also consider profit margin as well as your business history in deciding to extend purchase order financing. Purchase order financing can be an option for newer businesses and those rebuilding credit, making it an option when traditional bank financing is not available or not enough.

There are key advantages of purchase order financing that any business owner pursuing it should consider. These include: 

• Flexibility. In some cases, businesses can access 100% of the funds required to fulfill purchase orders, meaning zero cash up front. Of course, this can vary depending on the lender and even the terms of particular POs.
• Easy approval process. Approval for purchase order financing can often be much faster than traditional financing, giving you access to funds when you need it to keep your business moving forward—and fulfilling customer orders. 

• Lower personal risk.  With many business loans, business owners are required to sign a personal agreement. In the case of default, lenders can target personal assets to collect on an outstanding loan. In purchase order financing, personal guarantees are often required, however, your risk is lower because the financing company assumes the majority of the risk in expecting your customer to pay the invoice.   

• Payment terms and cash flow. Traditional business financing terms involve regular payments, made on a specific schedule until the loan is paid off. A repayment schedule can eat into cash flow. This is not the case with purchase order financing.

Regarding the cost, purchase order financing rates can vary depending on suppliers’ costs and payment terms.

Interested in exploring purchase order financing? We can help. Prairie Business Credit is a national working capital provider to young, growing, or recovering businesses. We offer accounts receivable financing, purchase order financing, and equipment financing. Our company serves both as a trusted financial resource and consultant to entrepreneurs dedicated to building their businesses and ensuring their success.