Purchase order financing has clear benefits for your business and lenders with both having the ultimate goals of satisfying customers and making a profit. Do you have enough cash on hand to cover future customer purchase orders? What if we told you there was a way to temporarily defer payments to suppliers for a small fee? Purchase order financing is gaining popularity among business owners because of the cashflow management benefits it can provide. However, choosing the right lender and understanding favorable terms are crucial to get a mutually beneficial contract.
What is Purchase Order Financing?
Purchase order financing works as an advance from a creditor that is used to purchase goods that you will eventually resell or distribute (Thunstrom, Fit Small Business). It can provide you with the goods necessary to scale your business without having to take out a bank loan or sell ownership in your company. Purchasing goods on credit will also allow you to maintain more control over your cashflow management.
There are some requirements that most lenders have when it comes to purchase order financing. The first is that your business must sell the finished goods to customers or the government and maintain a minimum profit margin of 15%. Profit margin is calculated by taking revenue minus costs and dividing that number by revenue. Other factors that lenders consider are creditworthiness and track record with customers and suppliers. If you have an established business and customer base, you will me more likely to receive the go ahead for purchase order financing. Do you own a startup? Good news! You are more likely to have relaxed terms because you don’t have a long history.
How Does Purchase Order Financing Work?
There are a few steps involved in a purchase order financing contract. The first step is to understand you have a cash flow management issue that requires additional financing when a large purchase order is received. Next, you will contact suppliers for the purchase order quote. You will then apply for purchase order financing and await approval confirmation. The purchase order financing company will then pay the supplier and the supplier will send the customer the goods. After the customer receives the goods, they will receive an invoice which will be paid directly to the purchase order financing company. Once the applicable fees are deducted by the purchase order financing company, you will receive the rest. Establishing a long business relationship with the prospective purchase order lender is essential, so choose wisely.
What are Favorable Terms I Should Look For?
Just like with any contract, you need to be sure you are getting the most favorable terms. The first thing you should look at is the interest rate and applicable fees. The standard interest rate is usually between 1.25% and 6% per month. Anything higher than 6% should raise a red flag and serve as your cue to seek out a different creditor. The next thing you should look at is the payback period. How many days do you have before you are liable for the amount due? If the customer does not pay within the allotted time period, you will be on the hook for the amount due. Making sure you have enough cashflow in the coming months to cover the purchase order, will help you avoid high fines and penalties.
Considering the terms of the purchase order financing contract is also crucial. Are there limitations on who you can sell to? What is the minimum order funding? How long until the supplier needs to be paid? Having answers to all of these questions will allow you to fully understand the contract you are entering into. The last thing you want is to be blindsided by terms that were clearly laid out in the contract you signed.
What are the Benefits of Purchase Order Financing?
Purchase order financing gives businesses the opportunity to effectively manage their cash flow. Instead of denying a large purchase order because your business does not have the cash on hand to make the purchase, you can serve the customer and gain revenue through purchase order financing. Freeing up the cash that would have been spent on the purchase order can allow your business to meet other operating expense needs, like paying employees or making rent payments.
Purchase order financing can also help you deal with a spike in business demand. If you have a significant number of orders coming in or have a new supplier, purchase order financing can help you manage the shift with ease. Reducing shipping costs is an additional benefit, since businesses with overseas suppliers usually have to pay for goods well before the customer remits payments.