Purchase order financing is a form of financing used by companies to fund their cost of goods from suppliers. It is a variable expense that is driven by customer orders. If you look on a company’s income statement you will see under gross revenues an entry for cost of goods sold. Purchase order financing covers the cost to suppliers required to deliver products to your customers. It can also be used to fund the cost of equipment which is a topic not covered in this article. For more information on equipment needs explore our sister company Equipment Finance Quotes.com.
Let’s look at this example of purchase order financing:
Sally has a growing business supplying components for medical equipment in hospitals and clinics. She has spent years developing relationships with her customers. To date, she has been able to cover the cost to suppliers internally through her own cash flow. However, due to recent marketing and stellar efforts by her sales people, orders have grown exponentially. She does not have the cash flow to cover the cost of goods and her suppliers do not offer credit terms for payment. Ordinarily, this would mean that Sally would not be able to fulfill the orders and the customers would go elsewhere. However, because of purchase order financing, she is able to meet customer orders, pay suppliers and deliver to her customers on time as ordered.
What is the cost of purchase order financing?
Purchase order financing ranges in cost between 2 and 3 percent on the amount of the money borrowed every 30 days. For example:
- $100,000 borrowed
- 60-day business cycle (the time from when the order is taken to the time when it is delivered and paid for by the customer)
- Interest charged at 2.5% per 30 days
- Total interest paid $5,000 ($100,000 X 5%) for the period
When is purchase order financing right for my business?
Let’s use the typical sales margin of 30%. This means that if you were to borrow $100,000 as in the example above, you would be selling your product to your customers for $130,000. Continuing with the above example, your profit would be $25,000 after the cost of financing. Utilizing this form of financing makes a lot of sense when it is used as the catalyst to propel the business forward. If this order was not able to be fulfilled due to lack of capital, the business would miss out on a $25,000 income opportunity. Additionally, purchase order financing grows with your business as sales get larger. This allows you to scale the company without worrying about how to afford delivering on the sales made.
How to qualify for purchase order financing.
This type of financing focuses on a few things:
- The amount of time your company has been in existence
- Delivery history – successful delivery of the products to customers using the same suppliers
- Credit and financial strength of the customers placing the orders
- The industry your company is in
Let’s look at each of these bullet points more closely.
The amount of time your company has been in existence.
The lender will look at the time in business to gauge the “execution risk” of your company. What they are looking for is whether or not your business has proven itself as supply products that are in demand. Time in business says to the lender that the company has made it past the startup phase and show promise as a continuing entity. This analysis can be offset by the 3rd point from above which will be covered below.
The lender is looking to see how long you have been using the same suppliers. Have there been any supplier issues in delivering the products? Any returns or issues from the customers? Any missed shipments or has the supply line been at all unreliable? These are some of the questions asked during the underwriting process.
Credit and financial strength of the customers placing orders.
This is of critical importance in analyzing purchase order financing requests. Possibly, the most important determinant in being approved or declined for a request. In basic terms, the customer placing the order needs to make the lender feel comfortable that they can afford the items they are ordering. If you are a startup company but selling to household names such as Walmart, Amazon, Target, etc. you have a high chance at approval regardless of time in business. The focus switches to the customer’s financial strength and the reliability of the supply line above all else. Alternatively, if you are a financially solid business with many years of proven history with suppliers but selling to small “mom and pop” stores with no credit history, an approval will be difficult. This is because the lender’s repayment source, the customer’s payment, can not be measured adequately.
Getting approved for purchase order financing is a subjective process based on the items above. Huntington Coast Capital has been in the space for more than 25 years and we guide our clients through the approval process. If purchase order funding is something that would benefit your company, give us a call for a free consultation 844-239-2632 or Apply Online.
To your success!