July 19, 2021
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A Guide to Purchase Order Financing
Purchase order financing is nothing new, but for many businesses that are finding it difficult to finance their business this past year and a half, purchase order financing is becoming very popular. However, like anything in the world of finance, there is no one way to do something, and purchase order financing is no exception. In this article we will explore the two most popular ways to obtain purchase order financing, from a purchase order financing company and an accounts receivable factoring company.
Purchase Order Financing Companies
It may seem like a no brainer that if you want purchase order financing you would go to a company that specializes in giving this. While these companies are an excellent option for many importers, they also have fairly strict requirements for financing that not all importers will be able to meet. The first requirement from these companies is that all products must be completely manufactured overseas, they will not finance anything manufactured domestically or that is a work in progress. Secondly, the product must ship directly from the manufacturer overseas to the customer who ordered the product, it can not transit through your warehouse. This means that you can't have product for other customers or for additional inventory in the same container.
Purchase order financing companies fund deals by obtaining a letter of credit from a bank. However, since they are dealing with a bank, and banks traditionally move at a very slow pace, you will need to ensure that you give them enough time to get you the letter of credit. If you need the funding tomorrow or even next week, then working with a purchase order financing company is not going to be an option.
Finally, these companies are only willing to handle very large deals such as half a million dollars, a million dollars, or even more. Since it can take a month or more to obtain the letter of credit, the last thing a purchase order financing company wants is for you to find the funds needed somewhere else during that time. When this happens, the purchase order financing company has invested time and money into securing a letter of credit that you ultimately will not need and will not pay for. Combined with the fact that it takes just as much time and effort to secure a small letter of credit as it does a larger one, it simply isn't worth it to purchase order financing companies to fund smaller deals.
Meeting all these requirements may prove difficult for many small businesses. However, if your company fits into these requirements then giving a call to a purchase order financing company would be a good idea.
Accounts Receivable Factoring Companies
If you don't meet the above requirements to work with a purchase order financing company, then working with an accounts receivable factoring company is probably what's best for your business. As the name suggests, accounts receivable factoring companies specialize in paying you for your receivables, meaning you have already shipped to and invoiced your customers. However, many factoring companies are also willing to give an advance based on a purchase order to their clients. They are also much less restrictive than purchase order financing companies, which makes them an ideal option for many small businesses.
In general, factoring companies do not provide a letter of credit, but instead provide you directly with funds. They don't require that products are made overseas, and are willing to fund a work in progress. The best part, the product can pass through your warehouse, so you can include additional product in the container whether it is for other orders or just for inventory. However, unlike purchase order financing companies, factoring companies prefer smaller deals. A typical deal for a factoring company might only be between $5,000 and $100,000 dollars, although if you have established a good working relationship with your factoring company, they may be willing to go much higher than that.
Factoring companies can move quickly, oftentimes you can just give them a phone call and they will tell you whether or not they can help you. However, factoring companies value relationships. Its easy for a factoring company to provide PO funding to a client that has been factoring for several years, but its much more difficult for a factoring company to say yes to PO funding for a company who they are speaking with for the very first time. So while existing clients will find it very easy to get a loan on a days notice, it will be much more difficult for prospective clients. As a result, if you foresee big things in your companies future, it may be worthwhile to establish a relationship with a factoring company that provides purchase order financing long before you get that first large purchase order.
In general, it is cheaper to obtain purchase order financing from a factoring company. However, factoring companies do not specialize in purchase order financing, and since they are actually funding you they need to get paid back. The way that they get paid back is through factoring the resulting receivables. The combined cost of both purchase order financing and factoring would be fairly comparable to if you had procured financing through a purchase order financing company. Although through factoring other receivables, you may be able to reduce the amount you need to borrow with purchase order financing, which will effectively make it more affordable. In general, factoring alone is much more affordable than any form of purchase order financing, so if factoring can provide you with the funds you need you may able to avoid purchase order financing all together. Plus, factoring provides you with additional benefits that you don't get from only purchase order financing.
Choosing What's Right for Your Business
In most situations you won't have a choice in which type of business to obtain purchase order financing from. The decision will be dictated by the requirements your deal meets and your existing relationships. However, both types of funding will provide your business with the ability to pursue a large purchase order. Furthermore, both options are much easier to secure than a loan or line of credit from a bank. So long as you can fit the cost of purchase order financing into your margins, it is one of the best ways to take on large orders and ultimately grow your business. Even if you haven't received a large purchase order yet, if you plan on pursuing one, now would be a good time to familiarize yourself with which options are available and start forming relationships.
At DSA Factors we are a factoring company that also provides purchase order financing. We work with our clients to make sure that they get the funds they need when they need them, while at the same time trying to minimize the amount of interest that they will need to pay. You can give us a call at 773-248-9000, email us at info@dsafactors.com, or chat with us right here on our website. We are always happy to answer any questions that you may have about purchase order financing or anything else.
