Whether you’re a small or large business, managing your costs is a large part of keeping your business successful. Having a steadily growing cash flow can help your business grow and take on more customers. But sometimes you need a little assistance. Finding the right source of funding can be difficult when there are many different solutions available. Purchase order financing, that we will discuss below, is one of them.
As a business, you don’t want to turn away a customer’s order because of a cash flow issue.Yet, at the same time you don’t want to take on a large amount of debt. Sometimes you just need a temporary boost because of a spike in orders during the season. One option that’s available is purchase order financing. This article will take a look at this financing option, and who may benefit from purchase order financing. You will also discover what you can do to manage the costs so that you can continue to grow and expand your business.
What Is Purchase Order Financing?
Purchase order financing is not a loan. This option allows your business to grow without taking on additional debt. The financing company looks at the creditworthiness of both your customers, and supplier, rather than your business. You can only use it to purchase the physical goods you need to fulfill a customer’s purchase order.
They pay your supplier with a line of credit, or with cash and pays to have the goods shipped directly to the customer. Once the customer receives the goods, they pay the financing company directly. After the finance institution deducts their fees, you get a payment of the difference.
Who Needs Purchase Order Financing the Most?
Seasonal sales spikes can sometimes exceed your business’ working capital, and during periods of more sales. Turning away potential customers isn’t an option. Your business may already have an existing line of credit. But the growth of the business is outpacing your resources. If you’re a small business, you may consistently have tight cash flow issues. All of these are good examples of when purchase order financing can help.
The types of business that can benefit purchase order financing includes:
- Importers/exporters of finished goods;
- Outsourced manufacturers, since they also work with a finished product.
How Much Is Usually Spent on Purchase Order Financing?
Purchase order financing can be an expensive short term funding solution.
- On average, the rates will be between 1.8%- 6% per month, with some companies having additional costs after thirty days of 1.25% per week.
- The rate is calculated on the amount of the purchase order that receives financing. For an example, a purchase order of $100,000 would cost between $1,800 and $6,000. This is why many financial companies that offer purchase order financing requires profit margins of at minimum of 15% with better rates the higher the profit margins.
- If your customers take more than thirty days to pay the invoice, there could also be additional fees. On average this is an additional 1.25% per week; using the $100,000 example, this can be $1,250 per week in fees.
In addition to the purchase order financing fees, there can be additional costs that come with this financing option. The financing company pays for the cost of shipping the merchandise to your customer. Therefore, your business may have to pay inspection, insurance, or shipping duty costs if your supplier is overseas.
3 Ways to Lower the Costs of Purchase Order Financing
1. Use Invoice Factoring to Cover Costs
If you receive a large order, and you’re waiting to receive payments for previous invoices, this can be a cheaper option fee wise. Rates vary from each financial company, but on average range between 0.5% and 5%. This can be a cheaper option than using purchase order financing.
Factoring businesses generally advance you 80% of the invoice’s value. So, once your customer pays the invoice, they send you the remaining 20% minus the fees. The longer it takes for your customers to pay for the invoice, the higher the costs will be over time. A big difference that separates invoice factoring from PO financing is that you can use the money for any business expenses that arise.
2. Contact your Supplier for Cheaper Financing Options
Sometimes you can work with your supplier on setting up terms to where you can pay for for the product after 30, 60, 90 days. This can allow you to get the product to fulfill orders and pay for them once your customers pay the invoice. Often though, your suppliers at times may have cash flow issues as well. Also, they may not be able to extend the terms of payment.
An alternative option that may work is called supply chain finance. With this option your supplier can extend terms like normal. However, if they need to get an advance prior to the end of the terms, an outside or funding company pays them the invoice amount minus a fee. The fee is based off of your risk to repay rather than the supplier’s. So, the rates for the supplier are usually lower than other financing solutions.
3. Establish a Line of Credit to Help Cover Costs of Business
Depending on the credit of your business, this can be another way of lowering costs of purchase order financing. Financial institutions that you’re already have a working relationship with can often provide less costly solutions.
Even if you already have a line of credit with a bank, some will be willing to to temporarily increase your line of credit to help with short term cash flow issues to help process orders for your customers.
The Bottom Line
Purchase order financing can be a useful funding method for helping your business to expand without taking on additional debt. You can also use it for meeting large orders from customers. Every funding option has a purpose. Therefore, we encourage you examine all available options for your business before making a decision.
What funding solutions have worked well for your business? Have you used purchase order financing in the past?
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