As business credit ratings drop, many businesses turn to purchase order financing to get quick cash to fill customer orders or to complete a project. While purchase order financing has several benefits there are also a few possible issues that entrepreneurs may face.
An Overview of Purchase Order Financing
What is purchase order financing? In brief, it is an agreement that allows your business to get the specific amount of a purchase order financed on short-term credit. The customer that is requesting the order must be an established business with a history of good credit and prompt payments. This is because the financing company is actually lending to the customer and simply using your business as a conduit to do so.
So, how does purchase order financing benefit a small business? It gives you an opportunity to get the goods you need without have the immediate cash to pay for them. It also frees you from having to meet the rigorous credit requirements of a traditional bank loan since the company is not specifically lending to you.
How the Purchase Order Financing Process Works
If you request purchase order financing, here's what you can expect. After you receive an order from your customer, the purchase order financing company will check and see whether the customer has a history of paying their invoices on time. If so, the lender will approve your request and issue a letter of credit to your supplier which will cover the cost of the goods. Instead of sending the supplies to you, though, the supplier will forward the goods directly to your customer.
After you receive confirmation that your customer has received the order, you'll send out your invoice as usual. However, the payment won't go directly to you. Instead, it will be sent to the P.O. financing company, which will then subtract its fee and send you the rest.
Things to Keep in Mind
Even though the purchase order financing process may sound simple there are a couple of things to remember. If there are any additional costs involved in shipping the goods such as inspection fees or insurance, you might have to foot the bill for them. It's also important to remember that the financing fees for the transaction may be rather steep, since the lender is taking on a substantial amount of risk by guaranteeing a payment that relies on the credit of a third party. When you're considering P.O. financing make sure you shop around for the best rate and only reserve this arrangement for customers that you know will pay their invoices.
Purchase order financing offers a convenient way for companies to fill their customers' orders even when their cash flow is reduced. If you carefully consider whether the arrangement is a good fit for your company you may well find that turning to purchase order financing helps your business continue to grow.