What is Purchase Order Financing and is It Right for Your Business?

What is Purchase Order Financing and is It Right for My Business?

You just got a big order but your inventory of supplies is down. No need to worry about losing the business. Purchase order financing can set you up with the supplies and inventory you’ll need to start that new job.  Small Business Trends interviewed Taylor Haddix, Funding Specialist at Segway Financial, LLC, to learn more about this financial tool.

“Purchase order financing works in hand with AR factoring. It’s a way to obtain funding for your business to start a job or purchase goods,” he said. Coupling these products together actually lowers the cost of the transaction because you can pay off the amount owed on the purchase order faster.

A Look at Purchase Order Financing

How It Works

A print shop might receive an order to complete a job. The business might not have the funds on hand to buy the bulk paper needed. The print shop gets a purchase order from a funding company. At that point the funding company can go to its paper supplier to get the inventory so the job can start.

“With that purchase order in hand, they can go to a purchase order funding company with the AR factoring included,” Haddix says. There they tell these funding companies about their plans to invoice for the work and what that entails. Essentially, you are presenting a note that says the company that placed the initial order owes you in the future.

Different Scenarios

Purchase order financing comes in handy in a variety of different scenarios. Say the company orders from your small business on a regular basis and you’ve just completed three big orders. You may have run out of raw materials but your client wants more finished product and places another large order. This financial tool allows your business to carry on seamlessly.

Purchase order financing companies are all unique. Haddix says each one will have unique requirements.

“There are ones that specialize in smaller higher risk invoices and there are ones that will only do Fortune 100 invoices.”

Underwriting Criteria

The underwriting criteria might have some wiggle room. However, there are some base lines you’ll need to meet as a small business. Lenders don’t want to see a negative credit history or bankruptcies on file for the company whose invoice they are buying. The pricing charged by these companies is often based on the profit margin for the project.

The first step in the process involves a purchase order financing company reviewing the economics to make sure everything is in order. The company can then pay the supplier who you are buying the raw goods from directly.

Invoice as Usual

“Once that payment is received, the supplier will deliver those goods,” Haddix  says. After these raw materials are turned into finished product and sold to the initial client, the small business can invoice as usual. The fee for using the purchase order funding company is covered in the invoice to the customer that made the order.

Haddix says it’s important to have the right numbers to take on purchase order financing.

“This could actually be a losing proposition with thin margins,” he says. “Typically, that’s a 20 percent gross margin so the transaction makes sense.”

One of the big advantages here to small business is you don’t need to turn away large orders.