Purchase Order Financing: How Does It Work And Who Benefits From It?
Updated: Oct 25, 2021
Invoice factoring is provided for companies that provide services or products for customers and have a need for added cash flow. Purchase Order Financing is provided to eligible customers who meet a certain set of criteria. The factoring process accelerates the accounts receivable process, so that companies have immediate access to the necessary funding. Loan terms are developed according to projected cash receipts. Companies with a profit margin of at least 25 percent benefit from Purchase Order Financing.
Why would a company benefit from purchase order financing?
Purchase order financing contracts are available for companies that want to increase their cash flow. Credit worthy customers can negotiate their terms anywhere between Net 10 and 120 days. Purchase Order Financing are ideal for customers working with their suppliers who want to limit their expenses and meet their cash flow needs as they await payment.
How does it work?
The secured financing option offers an advance solution for up to 90 percent of their invoice. The terms for such an agreement usually fall around 10 percent. The terms can be between 10 and 120 days depending on the profile of the customer. First, the customer makes a purchase. A letter of credit is then obtained from the financier. The letter conveys to the supplier that their funding will be assured. The supplier accepts funding from the financing company. This helps the company meet their funding needs to provide the necessary services to the customer or vendor. In order to satisfy the terms, the customer must pay off the invoice within three months. All parties are essentially a part of the financing agreement. The line of credit remains an option for merchants indefinitely.
Why it’s needed
The traditional lender may not offer financing and funding for certain types of merchants in scenarios where anticipated funding will be used for financing. The supplier is guaranteed a payment and can immediately begin the fulfillment process. The merchant provides the timely service to their customers and avoids any out-of-pocket expenses. The resources they need are available to fulfill the order. The customer gets their products on time. Some merchants require a bridge financing option in order to transact with customers to maximize their cash flow. Having the opportunity to invest cash flow as desired into other areas of the business is often beneficial for merchants, so a temporary line of credit accomplishes that goal.
Once a customer has applied for the line of credit, they never have to apply again. The terms are between 30 and 90 days. The customer can expect to pay 10 percent on average for the total amount of the purchase invoice. The creditworthiness of your customers is used to evaluate the application. Merchants serving creditworthy customers with higher ratings are more likely to get better terms and lower interest rates. Invoices should have no liens. Purchase order financing addresses these challenges.
Merchants who may not have access to traditional lines of credit or who are otherwise unable to increase their line of credit can use Purchase Order Financing to overcome their cash flow challenges. If a company suddenly sees an increase in purchase orders, the ability to fill that order quickly with limited cash on hand may mean missed business for the customer.