It is almost like a dream come true. After working very hard at your business, you get a huge purchase order from one of your best customers. You can almost feel the sweet taste of success. Soon, however, reality sets in. If you are like most small to mid size businesses, you realize that you don’t have enough money to buy supplies because your suppliers are demanding advance payment. You now risk losing the order unless you find a way to finance it.
If your company has been in business for many years, is reasonably big and has a great track record, you will probable be able to get a business line of credit or a similar type of bank financing. If that is the case, you’ll be able to borrow money to pay your suppliers and fulfill the order. But what options do you have if you are a new business owner or if you run a small business that has no bank credit?
There is a little known and seldom used financing product that could help you in this situation. As a matter of fact, it could help you almost any time you have a big sale to a good credit worthy customer. It is called purchase order financing (also known as purchase order funding or PO funding).
Purchase order funding can provide you with the financing you need to fulfill orders from your large and best credit worthy clients. As opposed to most financial products, the only collateral that purchase order financing requires is the actual purchase order (and associated payments) from your client. The financing company will provide you with the necessary capital to fulfill and deliver the order. They get paid when the client pays for the order. This makes it an ideal product for small and mid size businesses who are growing quickly and need capital to deliver orders to their ever growing client list.
Who qualifies for purchase order funding?
Purchase order funding is ideal for companies that re-sell a finished product at a profit. For example, import-export companies, wholesalers and distributors can certainly use this type of financing. However, if your company buys a product and modifies it before re-selling it, most probably it will not qualify for this type of financing (there are exceptions).
Although purchase order financing can be affordable if your profit margins are right, unfortunately it does not come cheap. This is because most financing companies consider the transaction to be high risk. The total cost of the transaction, from start to finish, can be anywhere between 5% and 15% of the sales price. Because of this, purchase order financing works best with businesses that have profit margins of 25% or more.
Lastly, purchase order funding only works for commercial sales in which the purchasing company has a good commercial credit score (as most large businesses tend to have).
How does the purchase order funding transaction work?
The transaction itself is actually fairly simple. Once you have the purchase order in hand you contact the purchase order funding company to begin the process. The first thing they will do is verify the credit worthiness of your customer. If the credit review is good, the transaction proceeds as follows:
1. The financing company issues a letter of credit in favor of your supplier. The letter of credit states that payment is guaranteed, provided the supplier delivers the product according to the buyer’s specifications. Almost all suppliers accept letters of credit as payment.
2. The supplier manufactures the product and ships it to you, or drop ships to the buyer.
3. The buyer receives the product and accepts it. Your supplier gets paid by cashing the letter of credit.
4. Your customer pays for the order, usually 30 days or so after receipt. The financing company is paid back for its services and all remaining funds are yours.
One of the remarkable features of purchase order funding is that in most cases, the client has few out of pocket expenses. It’s truly a transaction where you can use other people’s money to grow your business.
Lastly, purchase order financing transactions are frequently integrated with invoice factoring financing. This is a widely used trick that can help reduce the cost of financing the transaction, thereby increasing your profits.
Copyright (c) 2006 Commercial Capital LLC. All rights reserved. Article may be reprinted if not modified.
About Invoice Factoring Group
Invoice Factoring Group (http://factoring.qlfs.com) can provide you with a free purchase order financing and po funding quote. Marco Terry, its president, can be reached at (866) 730 1922.