Purchase Order Financing & Funding Guide

If you are a small business owner considering purchase order financing, or if you are just trying to learn more about purchase order financing while researching many different options for getting additional funds for your small business, you’re in the right place.

In this guide, we cover everything we’ve ever wondered or been asked about purchase order financing, and then some. Read on to learn:

The Problem With Purchase Orders

When a customer has agreed to buy a certain quantity of something from a supplier at a certain price point, they usually send over what’s called a purchase order. If you’re a small business owner and you receive a purchase order and agree to the terms on it, that purchase order document becomes a legally binding contract between the two parties: you and the buyer.

Sellers send out invoices to their customers, and buyers send out purchase orders to their suppliers.

While it’s great news when your small business gets a large purchase order, not every new company has the liquid cash needed to fill every order—particularly when multiple orders are on the table. As every small business owner knows, cash shortages practically come with the territory. In fact, 60% of small business owners worry about cash flow problems every month.

The last thing any business owner wants to do is turn away a large purchase order because their company’s cash is tied up. Instead of missing out on the potential to generate a ton of revenue or worrying about what being unable to fulfill a purchase order might mean for their business’ reputation, many suppliers that find themselves lacking the cash they need to ship goods are turning to purchase order financing solutions.

What is Purchase Order Financing?

Purchase order, or, “PO financing” is an arrangement where a third party agrees to give a supplier enough money to fund a customer’s purchase order.

In some cases, purchase order loans will finance an entire order while in other cases they may only finance a portion of it. When the supplier is ready to ship the order, the purchase order financing company collects payment directly from the customer. After subtracting their fees, the company then sends the balance of the invoice to your business.

Suppliers would probably prefer it if they never had to worry about financing large purchase order. Unfortunately, that’s not always the case. The good news is that by using PO loans to fund purchase orders, suppliers can fulfill their customers’ needs while continuing to grow their operations.

While small business owners used to expect traditional banking institutions to meet their financing needs, banks are lending fewer and fewer dollars in the wake of the 2007–2008 financial collapse. This is not to say banks no longer fund small businesses at all. They just tend to be picky, preferring to lend to companies that have near-perfect credit scores that have been in business for a long time.

Purchase order financing companies, on the other hand, are willing to fund suppliers even if they have less-than-ideal credit scores. These lenders are more interested in the creditworthiness of the customers that send in purchase orders. What’s more, while takes a lot of time to secure a loan from a traditional financial institution—assuming you’re lucky enough to qualify—PO loans are much easier to obtain. This is especially beneficial to newer companies that might have a large purchase order sprung on them when they’re not ready for it.

If you’re a small business owner worried about whether your company will have access to the cash it needs to fulfill the next large purchase order that comes in, PO financing may be just the solution you need.

Who Uses Purchase Order Financing?

If you find that you need to purchase items from suppliers before fulfilling a customer order, then purchase order financing might be a good option for you. Typically, the types of businesses that might use PO financing include:

Distributors
Outsourcers
Resellers
Wholesalers
Businesses with heavily seasonal sales patterns
Businesses with tight cash flow and a need to purchase materials before fulfilling orders

How Line of Credit Is Used For PO Financing

Business owners commonly use their business line of credit as a tool to help grow their business and accomplish more, faster. Here are a few examples of customers use of line of credit for Purchase order financing:

“Purchasing a new piece of equipment”
“Purchase extra inventory”
“Stay competitive on terms to win new business”
“Avoid out of pocket expense on future purchase orders”
“Buy materials necessary to deliver a project”
“Flexible PO financing source without commitment”

A business line of credit may give you access to funds required to finance your purchase orders.

How Does Purchase Order Financing Work?

Let’s say a customer places a large order. After checking with your supplier, you realize you don’t have enough cash on hand to fulfill the order. You review your options and ultimately decide to give purchase order financing a try.

Here’s what happens next:

You reach out to the PO financing lender, sending along the purchase order itself and your supplier’s estimate.
Assuming a provider approves you for financing, the provider pays your supplier and your order gets filled.
The supplier sends the products to the customer.
You then invoice your customer for the goods.
The customer sends their payment directly to the financing company.
After deducting their fees—which can be as high as 6% each month—the financing company sends you the remaining balance.

There are a lot of moving parts in these transactions.

What happens if your supplier ends up taking a lot longer than they predicted to fill an order? Will your customers still want the goods from you—or will they turn to one of your competitors? In the event they still want to do business, you may end up owing the financing company more interest as time goes on, depending on the terms of your contract. You may also have to offer your customers additional payment discounts to keep them happy.

How to Apply and Qualify for Purchase Order Financing

Like most forms of small business financing, applying for purchase order financing can be a time-consuming endeavor. After doing your due diligence and finding the provider you’d like to partner with, you’ll generally have to submit several documents, including:

The purchase order from your customers
Your supplier’s invoice to you
Your invoice to your customer
Your purchase order to your supplier
Business information
Legal information (e.g., any pending lawsuits?)
Financial statements (e.g., P&L statements and balance sheet)
Tax filings

Different lenders have different criteria for approval. On average, however, companies that qualify for purchase order financing usually tend to have the following traits in common:

The company (borrower) doesn’t make the products it sells. Instead, it just resells products from the supplier, adding their own packaging and labeling.
The price of the sale typically needs to be at least $50,000.
The gross margin on the transaction needs to be at least 20%, if not more.
The customer involved in the deal needs to be creditworthy. PO financing lenders will conduct a detailed credit check on your customers to determine their creditworthiness. Some lenders will do a business credit check on your customers. Others will not, but they will still look for things such as whether the customer has a record of timely payments, bankruptcies, or litigation.
The supplier needs be reputable with a track record of delivering orders on time, made to customer specifications.
The transaction needs to be non-cancelable.
The borrower needs to have a good reputation and be in good financial standing.

Assuming your small business meets the above criteria, you may find that purchase order financing is just what you need to get to the next level. However, in the event you’re unable to deliver the items on an order less than $50,000—or one with lower margins—you’ll most likely have to look elsewhere for financing.

Pros and Cons of Purchase Order Financing

Does purchase order financing make sense for your business? To answer that question, you need to weigh the pros and cons.

On the plus side, purchase order financing gives you the money you need to fulfill an order you otherwise couldn’t. It’s not a loan, so you won’t have to make monthly installments to settle a debt.

While it may take a while to find your first PO financier, once you’ve established a successful relationship with one, it should be fairly quick and easy to secure financing when you need it. What’s more, the financing company also acts as a collection agency, so you don’t have to worry about trying to track down payments from your customers. Since PO financing companies care more about the purchase orders themselves than your particular financial situation, you may qualify for funding even if you have bad credit.

Purchase order financing, however, is not without its downsides. For starters, the lender will take a percentage of the entire purchase order once they’ve been paid by the customer, which puts a ceiling on your profitability. Depending on the lender, this fee can be quite significant. On average, it ranges from 1.8%–6% each month. Since your customers will end up having to pay the financier directly—just like invoice factoring—they may become aware of your cash flow struggles.

PO financing only works with products; if yours is a service-based business, you’ll have to look elsewhere for financing. Additionally, most purchase order financing companies are only willing to bankroll large orders. If you get a few smaller orders in and can’t finance them yourself, you’ll have to find money elsewhere. Finally, purchase order financing only covers the costs of orders. You can’t use the money to grow your business in any other way.

Pros of Using Purchase Order Financing

Lets you take on orders you otherwise wouldn’t be able to fulfill
Fast and easy financing once you’ve built a relationship
Save time by not having to collect payments from customers
No monthly installments
You may qualify even with bad credit

Cons of Using Purchase Order Financing

It can be quite expensive compared to other financing options
Your customers may assume that your business has cash flow problems
It only covers the costs associated with producing or purchasing physical products
It may not cover smaller orders
It is not very flexible, in that it only covers purchase orders; you can’t use the money for anything else, such as other business expenses

Alternatives to Purchase Order Financing

The good news is that if PO financing isn’t the right financial vehicle for your small business, you’re not out of luck. There are a number of alternatives to purchase order financing that you can use to get the cash you need to grow your company. Here are just a few of the most common ones.

Invoice Factoring is the process of selling your unpaid accounts receivables at a discount in exchange for immediate cash. Factoring is a temporary financing option that can help you overcome cash flow gaps. At the same time, however, it’s considered one of the most expensive forms of small business financing. Additionally, invoice factoring companies collect payments directly from your customers, which could clue them in to your cash flow struggles.

Invoice Financing is a form of small business funding where companies borrow against their outstanding invoices instead of selling them to a factor. Companies that go this route can partner with a lender like Fundbox and choose which invoices they’d like to advance payment on, up to the approved credit limit, whenever they need cash. Once they’ve chosen which invoices to clear, they can get the full amount of each invoice in as fast as one business day. They then have a predetermined amount of time to repay the advance, plus a flat fee. Unlike factoring, invoice financing enables you to overcome cash gaps without your customers becoming aware of your financial situation because they continue paying you directly.

Merchant Cash Advances are made to qualifying businesses that process a lot of credit card transactions each month. Beware, though, that this form of financing is extremely expensive. You get a cash advance in exchange for a fixed percentage of future credit card receipts, so you don’t have to worry about being unable to repay an installment. Each month, for example, you might owe your lender 10% of all credit card sales until the debt is settled. That might not sound so bad until you realize the MCA lender is debiting your account daily. Depending on how business goes, it could take quite some time before your debt is repaid. You may also find yourself entering a debt spiral that’s difficult or impossible to overcome.

Traditional Term Loans used to be the go-to option of small business financing for all kinds of companies. However, in the aftermath of the financial collapse, fewer and fewer banks are funding small businesses. In fact, recent data suggests banks only sign off on one out of four small business loans that come their way. Most of them prefer to lend to larger organizations that have spectacular finances and perfect credit scores. Still, some banks will fund the right small businesses. It will take a lot of time to apply and, if you’re approved, you may have to wait several weeks or months for money to finally come your way.

Loans From Non-Bank Lenders have emerged in recent years as a vehicle to finance the small businesses banks have forgotten. While it’s easy to qualify for these kinds of loans and the application process isn’t cumbersome, they often come with substantially high interest rates. In the event your business goes under, you’ll be liable to repay the lender, plus interest.

Outside Investors can also help finance your business. You just have to be willing to give up equity or take on debt. Partner with the right investor and you’ll benefit from someone who knows what they’re doing and has a lot of connections that can help your business grow. You may, however, have to give up some control of your operations. If you choose to sell equity, you’ll also have to prepare to take home a smaller piece of the pie as you’ll have to share profits with other owners.

Business lines of credit can be used to finance small businesses on a temporary basis. You only have to pay interest on the money you spend, but there may be fees attached to opening and maintaining the credit line. Business lines of credit may also lead to additional financial troubles in the event business doesn’t go as you hope it will. If you max out your credit line and aren’t generating the revenue needed to pay it back, you may have to take on yet another loan just to settle your account.

Are you looking for ways to get funding for your small business? Do you need to advance funds to help you manage cash flow gaps, or take advantage of growth opportunities? If so, you’ve come to the right place. We’re here to help.