Table of Contents
Purchase order financing is a funding solution that helps businesses fulfill large customer orders without upfront capital. This financial option is particularly useful for businesses experiencing rapid growth or dealing with large, one-time orders.
Purchase order funding comes at a relatively high cost, however. Here’s what you need to know about this type of arrangement, how it works, its pros and cons, plus alternatives you might consider.
Key Points
• Purchase order financing provides businesses with upfront capital to pay suppliers, enabling them to fulfill large customer orders without depleting cash reserves.
• This type of funding is an advance based on a specific order and is repaid once the customer pays, unlike traditional loans.
• PO financing is ideal for companies experiencing rapid growth or handling large orders they couldn’t otherwise afford.
• Fees and interest can be higher than with traditional loans, but PO financing helps businesses prevent missed opportunities due to limited cash flow.
Purchase Order Financing Definition
Purchase order financing, also known as PO financing, is essentially a cash advance that a company can use to fulfill its purchase orders. With this type of financing, a lender will pay a third-party supplier up to 100% of the cost involved in producing and delivering goods to your customers.
You may qualify for PO financing even if you have a spotty credit history. Purchase order financing companies are typically willing to work with small businesses and startups with bad credit. These lenders tend to be mostly concerned about the creditworthiness of your customers, since the customers will be repaying much of the loan.
How Purchase Order Financing Works
To understand how purchase order funding works, here’s a step-by-step example.
1. Let’s say you receive a large order from a customer but discover that you don’t have enough inventory on hand to fill it.
2. After reaching out to your supplier, you determine that you don’t have enough available cash to purchase the goods you’d need to fulfill the order, either.
3. Rather than turn your customer away, you reach out to a purchase order finance company.
4. As part of your application for funding, you send the lender your purchase order as well as your supplier’s estimate.
5. If the lender approves you for PO financing, they will then pay your supplier most or all of the invoiced amount. If, for example, the lender approves you for just 90% of the supplier’s costs, you would need to cover the remaining 10% on your own.
6. The supplier then fills the order and sends the product to your customer.
7. Next, you invoice your customer, who sends payment directly to the lender.
8. The lender then deducts their fees and sends you the balance.
Grow Your Business the Right Way.
Explore small business funding options in one place with no impact to your credit score.*
Who Uses Purchase Order Financing?
You might consider PO financing if your business needs to buy goods or supplies from a third party, but you don’t have enough cash reserves to make those purchases or strong enough credit for a traditional small business loan.
Types of companies that may use PO financing include:
• Startups
• Business owners with low credit scores
• Wholesalers
• Distributors
• Resellers
• Importers/exporters of finished goods
• Outsourcers
• Government contractors who are fulfilling government orders
• Companies with seasonal sales
Pros and Cons of Purchase Order Financing
As with all methods of funding a small business, there are advantages and disadvantages to purchase order finance. Here’s a look at how the pros and cons stack up.
Pros
• Enables you to take customer orders you otherwise could not fulfill. Purchase order financing allows you to serve customers despite seasonal dips in cash flow and/or take on an unusually large order from a customer.
• Can be easier to get than other types of business loans. While PO financing companies will look at your business’s financials and credit history, they are typically more interested in the creditworthiness of your customers and the reputation of your supplier. As a result, it can be easier for startups and businesses with less-than-stellar credit to qualify for PO financing compared with other types of business funding.
• You don’t need to make regular loan payments. Since PO financing is more of a cash advance than a loan (similar to invoice financing), you won’t need to pay the money back in regular installments like you would with an ordinary business loan.
Cons
• Can be costly. PO financing fees may seem relatively low at first glance, often ranging between 1% and 6% of the total supplier’s costs per month. But when that rate is converted into an annual percentage rate (APR), purchase order loan rates are actually fairly high, potentially 20% or significantly more.
• Final cost depends on your customer. Since fees are charged per month, how much you will end up owing the PO financing company will depend on how long it takes your customer to pay their invoice. This can make it difficult to estimate the total cost upfront.
• You’re cut out of the process. With this type of financing, the lender and supplier often take over most of what you normally do. In many cases, the lender will pay the supplier, the supplier will ship the product to the customer, and the customer will pay the lender. As a result, you won’t have the usual amount of quality control.
Recommended: 5 Crowdfunding Sites to Help Fund Your Business
Key Considerations Before Choosing PO Financing
When beginning to shop for financing companies, remember that some lenders focus on specific industries. Zeroing in on specialists can help you find a purchase order loan provider that truly understands your business.
Costs and Fees
PO financing providers generally charge fees, interest, or discount rates on a transaction. Business owners should get all those details upfront to figure out whether the revenue margin is large enough to make up for the financing fees.
For context, it may be worth also comparing costs, terms, and approval requirements for PO financing vs. standard small business loan fees.
Supplier and Customer Reliability
It’s prudent for businesses considering PO financing to do their due diligence on their suppliers, customers, and funding company. It’s an even better idea if suppliers and/or customers are based overseas, since commercial regulations can vary widely between countries.
Applying for Purchase Order Financing
Purchase order financing is primarily offered by online financing companies. Some banks offer PO financing, but typically only to large companies or existing clients.
To qualify for PO financing, you usually need to:
• Have a purchase order of $50,000 or more
• Sell finished goods (not parts or raw materials) that you don’t make yourself
• Sell to business-to-business (B2B) or business-to-government (B2G) customers
• Have profit margins of at least 20%
• Have creditworthy customers (some lenders will conduct a detailed credit check on your customers)
• Have reputable and trustworthy suppliers
If you meet the basic criteria for PO financing and want to apply, you’ll typically need to have the following documents:
• The customer’s PO
• Your supplier’s invoice
• Your invoice to your customer
• Your purchase order to your supplier
• Information about your business
• Financial statements (such as your balance sheet, income statement, and cash flow statement)
• Tax returns
Recommended: What Is EBITDA?
Alternatives to Purchase Order Financing
If PO financing doesn’t sound like the right financing solution for your business, you’re not necessarily out of luck. There are a number of other small business financing options that can smooth out dips in cash flow and help you grow your business. Here are some to consider.
Invoice Factoring
Invoice factoring is a type of invoice financing that involves “selling” some or all of your company’s outstanding invoices to a third party, called an invoice factoring company. The factoring company will typically pay you 80% to 90% of the invoice amounts, then collect payment directly from your customers. Once the factoring company gets paid by your customers, the company will pay you the remaining invoice amount — minus any fees.
Small Business Loans
With a traditional term business loan, you receive a lump sum of capital upfront and then pay it back (plus interest) in regular installments over a set term. While banks typically have strict criteria for business loans, online business lenders tend to have more flexible qualification requirements and are faster to fund. A short-term business loan from an online lender can help solve a short-term cash crisis, but rates and terms are generally higher than bank loans.
Merchant Cash Advances
A merchant cash advance (MCA) might be an option if you do business using credit card transactions. With an MCA, you get a cash advance in exchange for a fixed percentage of future credit card receipts. Typically, the MCA provider automatically deducts a daily (or weekly) percentage of your debit and credit card sales until the advance, plus fees, is repaid in full. While an MCA can be a quick source of cash, overall it’s one of the most expensive ways to finance a small business.
Business Lines of Credit
You can also use a business line of credit for short-term financing. Similar to how a credit card works, a line of credit allows you to draw up to a certain limit and only pay interest on the money you borrow. You then repay the funds and can continue to draw on the line. A business line of credit can be used for a variety of immediate needs, such as managing cash flow, buying inventory, or paying employees.
Recommended: Bad Credit Business Loans
The Takeaway
Purchase order financing allows a business to fulfill customer purchases when its cash flow is insufficient. It’s a type of cash advance — similar in some ways to accounts receivable financing — in which a financing company covers supplier costs on the business’s behalf and collects money directly from the customer. The funding company then deducts fees and pays the leftover balance to the business.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Is PO financing a loan?
Purchase order financing is not a traditional loan, as it doesn’t provide you with a lump sum of capital that you then pay back in installments. Instead, it’s considered a cash advance.
What documents are required for purchase order financing?
To apply for purchase order financing, you’ll need to provide a number of documents. These may include the customer’s purchase order, your supplier’s invoice, information about your business, financial statements (such as your balance sheet, income statement, and cash flow statement), and personal and business tax returns.
Can purchase orders be used as collateral?
Yes, purchase orders can be used as collateral in purchase order financing. Lenders consider the purchase order as a guarantee of future payment from a customer, advancing funds to cover supplier costs. The order itself serves as security, ensuring repayment once the customer fulfills their payment obligations.
What is the difference between purchasing order financing and invoice financing?
Purchase order financing funds suppliers upfront to fulfill customer orders, covering the cost of goods before they’re sold. Invoice financing, on the other hand, provides cash advances based on unpaid customer invoices, helping businesses access cash after a sale is made but before the customer pays the invoice.
What types of businesses benefit most from purchase order financing?
Product-based businesses such as importers, wholesalers, distributors, and manufacturers can all benefit from PO financing. This method of funding can help companies settle up with suppliers sooner, since they don’t have to wait on customer payments. Seasonal businesses, too, may be able to streamline their inventory management using this approach.
Photo credit: iStock/Kerkez
SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.
This content is provided for informational and educational purposes only and should not be construed as financial advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SOSMB-Q325-036