Purchase order financing is a form of short-term funding that provides the cash companies need to pay their suppliers up-front for a customer order.
Also sometimes called “P.O. financing,” the advance funding of purchase orders is an effective tool for business owners who don’t want to turn down a customer request because they lack the cash to fulfill it. Purchase order financing enables companies to handle big orders, enhance customer and supplier relationships, and improve their order volume.
How Purchase Order Financing Works
When you enter a purchase order financing arrangement, four parties are involved—your business, your supplier, your customer and a purchase order financing company.
Here's an example of how it works:
1. Your company receives an order from a customer.
2. The purchase order financing company pays your supplier for goods that must be purchased to complete the order.
3. The purchase order financing company collects payment from your customer.
4. The purchase order financing company pays your company the customer invoice amount, minus fees.
How is Purchase Order Financing Different from Factoring?
Companies that use purchase order financing have a different cash flow need than those that use factoring.
Factoring clients need funding to keep cash coming in during the 30- to 60-day period between when they complete and job and the customer pays. Companies that use purchase order financing need cash up front in order to complete work for a client.
In short, factoring funds the customer invoice, while purchase order financing funds the customer order.
In many cases, purchase order financing clients may only need to fund a portion of the expense of fulfilling a large customer order. However, 100% financing also available on purchase orders.
Who Uses Purchase Order Financing?
A wide variety of businesses turn to purchase order financing to address needs like tight cash flow, growth plans or seasonal customer demand. Companies that finance their purchase orders include:
- Start-up businesses
- Government contactors
- Import/export companies
How to Qualify for Funding
It is easier for companies to finance their purchase orders than to receive a bank loan or line of credit. As with factoring, purchase order financing providers are more concerned about the creditworthiness of a client’s customers than that of the client itself. Also like factoring, the funding provided by purchase order financing is not a loan. The client assumes no debt.
The costs associated with purchase order financing can vary for each transaction. The purchase order financing provider’s underwriting standards, as well as the credit risk of the customer involved, help determine the fees. The cost of financing typically ranges between 1.5% to 6% of the value of the purchase orders funded per month.