What is Purchase Order Financing?

Purchase order financing is a short-term financing method used to cover the cost of manufacturing or purchasing of goods that have been pre-sold to customers through a purchase order. Businesses then send invoices to their customers, who send their payments directly to the PO financing company.

The advantage of PO financing is that it is much faster than traditional financing and it’s your customers’ creditworthiness that is considered not yours. Additionally, PO financing is not new to the business world. It is a very common tool for many businesses in a variety of industries.

How Does Purchase Order Financing Work?

Imagine receiving a purchase order from your best customer for goods you don’t have in stock. You need to either manufacture the product or purchase it from someone else, but you don’t have the capital to do either. What are you going to do?

If you decline to take on the new order you risk losing the new customer, which could lose a long-term earning opportunity for your company. Universal Funding offers a solution to this cash-flow dilemma: Purchase Order Financing.

  1. Customer Orders: Your receive purchase orders from your customers.
  2. Cost Estimate: You provide the cost breakdown of the purchase order to Universal Funding including materials and/or labor.
  3. Funding: You and or your supplier is paid by Universal Funding. This may be for supplies, materials, and/or labor.
  4. Order Fulfilled: You and/or your supplier fulfills the order and your customer accepts the goods.
  5. Invoicing: You invoice your customer for the fulfilled order. You then submit your invoices to Universal Funding for factoring.
  6. Invoice Factored: The proceeds of factoring pays off the purchase order funding and the remaining advance goes to you.
  7. Customer Pays: Your customer pays their invoice directly to Universal Funding.
  8. Final Close-out: Universal Funding deducts the advance and the fees, then pays you the remaining balance.

Now the order has been fulfilled without taking on more debt and you earn the profits instead of having to turn down the business.

How Does Purchase Order Financing Improve Cash Flow?

Purchase order financing, or PO financing, can help small businesses and newer companies who may be having a difficult time filling large orders. Companies use purchase orders to record orders from their customers. These purchase orders, create a contract between a company and their customer. It means that the customer promises to pay after the products are delivered. Because this arrangement creates a contract, it makes the purchase order valuable to companies known as factors. A factor can fund a purchase order from a company and provide them with the cash they need to produce and fulfill their order.

Can Purchase Order Funding Fuel Growth?

Purchase order financing is an often overlooked way to get the cash you need to grow your business. A purchase order signifies a promise to pay and can be used to obtain the cash you need to fulfill your orders. By financing your purchase orders with a PO financing company, you will have the cash to fill new orders. PO financing for sales growth can be a great option for many growing businesses.

What’s the Difference Between Purchase Order Financing and Invoice Factoring?

If you are a business owner in need of immediate financing, you may be considering Purchase Order Financing or Invoice Factoring, especially with the rising interest rates of traditional bank loans. While these two options have similar origins, they are two different financing tools for businesses. With so much information available on purchase order financing and invoice factoring, it might be confusing about which one is best for your business. Following is a comparison of the two types of financing methods.

PO Financing vs Invoice Factoring: Which is Best?

Purchase order financing is a short-term financing method used to obtains quick access to working capital to cover the cost of manufacturing or purchasing of goods that have been presold through a purchase order.

PO financing is used when your suppliers receive funds from a financing company for goods that you’re reselling or distributing, but have not yet produced. Payment for the goods purchased from your company will then go to the purchase order financing company.

Invoice factoring involves a business selling its invoices or accounts receivable to a factoring company for an advance rate that can range from 80-95%. The invoices are unpaid invoices from another business and the factoring company receives the payment from customers on the invoices. You then receive the balance minus the factoring fee.

What are the Similarities Between PO Financing and Invoice Factoring?

  • Quick Financing. Compared to the lengthy process of traditional financing, PO financing and invoice factoring can be obtained in a matter of days.
  • Credit Worthiness. Both methods of financing focus on the credit worthiness of your client rather than your balance sheet. While banks look to your past history of managing your company’s finances and credit, when determining if a line of credit or loan will be approved.
  • Great for Newer Companies. Since factoring companies put more weight on the clients’ creditworthiness, younger businesses are often able to qualify for the financing they need.
  • Credit Line Grows as You Grow. Lines of credit can get maxed out rather quickly, especially when experiencing rapid growth. With invoice factoring and PO financing, your facility limit grows along with your company providing more funds when you need allowing you to sustain growth.

How are Invoice Factoring and PO Financing Different?

  • Cost of Capital. While rates vary, the cost of PO Financing typically is more expensive than invoice factoring.
  • Profit Margin. PO financing companies often require a profit margin around 20% on purchase orders.
  • Service-Based Companies. If you provide professional services, such as temporary staffing, purchase order financing would not be available to you. PO financing is tool that can only be used when a physical product is being purchase. Invoice factoring can be used for companies that sell products or provide services in a B2B environment.
  • How Funds Can Be Used. While PO financing can finance up to 100% of the cost of producing a product, including materials and labor, funds can’t be used for anything else. With invoice factoring there are typically no restriction on what the working capital can be used for.
  • Supplier Requires COD. If a supplier requires payment as COD, PO financing can be the best route for a company if they do not have the cash available to purchase the materials in full.
  • Supplier Net Terms. If the materials supplier offers net terms that allow enough time to produce the finished product and deliver to the end customer, invoice factoring is the preferred financing method. Once delivered, the company can then submit the invoice to the factoring company who will quickly advance the funds needed to pay the suppliers at a lower cost compared to purchase order financing.

While purchase order financing and invoice factoring are clearly different forms of financing, their purpose is the same—to create cash flow and augment business growth.

If you’d like to learn more about PO financing, give us a call today at 800.405.6035 or complete a rate form and a funding specialist will get in touch with you right away.


Related: 10 Considerations When Selecting the Best Factoring Company for Your Business

Watch this video to learn about purchase order financing.

Learn how Purchase Order Financing helps companies fulfill customer orders.

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