Using your purchase orders to secure funding helps your business supply customers while increasing production capacity.
If your business is having trouble filling orders, you may want to consider using purchase orders as collateral to pay suppliers. Referred to as purchase order financing, it's a popular option for small- and medium-sized business owners because it can be a short-term solution to temporary cash flow problems.
This guide will take you through what you need to know about purchase order financing.
How does purchase order financing work?
Purchase order financing can be the ideal solution for resolving cash flow problems and getting outstanding orders filled. Using the purchase order as security, the lender will pay your suppliers on your behalf. Once the suppliers have delivered the finished goods to your customer, the customer will pay the lender and you will collect the profit. This way, your business can continue to fill orders, take on more work and ultimately expand and develop its capacity.
The purchase order finance process
- You receive a purchase order from your customer
- You apply for funding from a lender using the purchase order as collateral
- The lender contacts the customer to verify the purchase order
- The lender then pays your supplier, who ships the finished goods to your customer
- The customer pays the lender
- The lender transfers any profit to you
How you can compare purchase order financing
Here are some factors to consider when comparing purchase order finance loans:
- Lending criteria. Purchase order finance is usually offered by alternative lenders where the lending criteria are more flexible than those of banks.
- Verification. The lender takes a risk financing your purchase order, so the authenticity and validity of the purchase order will be verified with the customer and supplier.
- Short-term. This is a short-term solution to cash flow problems, meant to help bridge the gap between receiving an order and collecting the profit once the customer pays. If you require a larger loan you may want to explore other loan options that may be better suited to your needs.
- Maximum amounts. This depends on the lender, the size of your purchase order and your business's capacity to fill the order. Some lenders set minimum and maximum loan amounts, so do some research based on the size of your order.
- Local and overseas suppliers. If your suppliers or customers are overseas, make sure that the lender is aware of this and will agree to provide finance.
What are the benefits and drawbacks?
- Unsecured financing. Besides the purchase order itself, your business doesn't have to put up security for this loan.
- Safe. Lenders cover all bases before approving financing, including validating the authenticity of your purchase order with suppliers and customers. The funding goes straight to the supplier who sends the finished goods to your customers.
- Simple to procure. You can apply for purchase order financing online. Approval is fast so that you can supply your customers as quickly as possible.
- Short-term.This is a short-term loan designed to resolve temporary cash flow problems. If you have more serious financial issues, a different loan type might be more suitable for you.
- Finished goods only. Purchase order finance can be used for finished goods only.
Is there anything to avoid?
- Product inspection. Once delivered, the customer will do an inspection of the finished product. It's imperative that the order is correct; a delivery mistake reflects poorly on both your business and the lender.
- Risk. Before applying for finance, make sure that your business can fill the order. If you can't meet the obligation, you might have difficulty being approved for a loan in the future.
Common questions about financing purchase orders
Who will lend money against a purchase order?
You will most likely get funding from smaller, online lenders rather than traditional banks. Lending criteria is more flexible and they're willing to lend smaller amounts to small- and medium-sized businesses.
What are the criteria that my business needs to fulfill?
Most lenders require that your business isn't encumbered by too many existing loans and that it doesn't have legal or tax issues. Your business should also have relatively good profit margins and work with reputable commercial partners. In most cases, the purchase order should be non-cancellable and for finished goods only.
Will I get funding equal to the whole purchase order?
This differs from lender to lender. Some will lend 70% of the total purchase order, while others will lend as much as 90%.