Business owners are excited to grow their business and rarely begrudge any customer that shows interest in dealing with their startup. In the heat of the moment, some large orders may be accepted that the business may not be able to afford to fulfill. A better alternative to breaking the contract (which you never want to do) or taking a loan is purchase order-financing. This form of funding can aid startups and even smaller-scale businesses in gaining the trust of their buyers, by actually leveraging the trustworthiness of those buyers in securing the financing. If we analyze the application process and advantages of purchase order-financing over taking a loan, we can find out which is the most useful for a given business scenario.
What is purchase order financing?
Large orders with customer specifications sometimes can be beyond a business’ budget to fulfill. In such circumstances, the system of purchase order finance is suggested to wholesale and/or retail resellers. With purchase order financing, there are three major parties that take part in the financing process. While the reseller (that’s you) and the customer are the main parties, a third-party financing company or PO company (purchase order financing company) pays the supplier directly in order to complete the transaction. On receiving an order from an end user, the purchase order is generated for a supplier, which is submitted to the financing company for review. Purchase order financing is usually processed in the following way:
1. A reseller takes an order from their customer
2. The supplier is sent a purchase order and provides a written proposal, including all costs
3. The purchase order documents are sent to a PO company for financing
4. The supplier receives payment directly from the financing company
5. The supplier (typically) provides the order directly to the customer
6. Any outstanding balance on the financing is (sometimes) paid directly by the customer
How safe is purchase order financing?
Purchase order financing is a reliable and trustworthy option. However, it is only suggested under the following considerations:
1. The order is from a trustworthy customer: approval for purchase order financing often depends more on the creditworthiness and reputation of the other parties involved in the deal, rather than on your business’ credit history.
2. The supplier is renowned in your industry and region: just as with the customer creditworthiness requirement, PO companies often look at the credit history of the manufacturer or supplier you’re buying from to supply your customer.
3. Gross profit margin is high: a PO company will want to see this as a “sure thing,” which means you’ll need to have a good markup on items bought from a supplier for sale to an end user.
4. Your business is a reseller (either a wholesaler or retailer): purchase order financing is generally only available to companies that deal in physical products, and the resale of goods from a direct manufacturer is one of the few conditions that qualifies for such financing.