How AR and PO Financing Work [Infographic]
If you can’t qualify for a traditional business loan, or if you don’t have time to wait for those funds, there are other alternative financing options that might be the answer — especially when those funds will equal a big return.
AR and PO financing (accounts receivable and purchase order financing) are two choices for many business owners when they need immediate capital, or have lower credit scores.
How Accounts Receivable Financing Works
Accounts receivable financing is the selling of outstanding invoices or receivables at a discount to a finance or factoring company that assumes the risk on the receivables and provides quick cash to your business.
Basically, accounts receivables are given to the finance company, and the finance company spits it back out as cash in your pocket. How much they are worth depends on their age. More current invoices pay more. Any over 90 days are typically not financed.
Benefits of AR Financing
- Pass off collections
- Free up working capital
- Quick financing
Standard Costs of AR Financing
There’s usually a service fee and interest. Those can vary. But there can also be hidden charges, including penalty fees, renewal fees, insurance costs and re-factoring charges for debts over 90 days old.
What is Purchase Order Financing?
Purchase Order Financing (or PO Financing) is a loan or advance, secured by a purchase order or contract, to pay for inputs, raw materials, packaging, goods for resale, etc., needed to produce and ship a product or deliver a service.
How Does PO Financing Work?
- 1. A company obtains a verified purchase order or a contract from a customer.
- 2. The company estimates the direct costs required to produce and deliver the product or service.
- 3. The company approaches a lender about financing using the contract as collateral.
- 4. The lender evaluates the creditworthiness of the customer that issued the purchase order and assesses whether the company can deliver according to the terms of the order/contract.
- 5. If the loan is approved, the lender advances a percentage of the total order value to enable the company to produce and ship the order (or deliver the service) and issue the invoice to the customer.
- 6. When the customer pays the invoice, the lender is repaid the principle, interest and any fees and remits the balance to the company.
Benefits of PO Financing
- 1. It’s not a loan
- 2. Pays your supplier
- 3. Allows you to take on big jobs
- 4. Includes collections
- 5. Doesn’t require A-1 credit
Businesses that can benefit from PO Financing
- 1. Manufactured goods, not services
- 2. Profits margin on the order will be 20% or more
- 3. Your customer is established and creditworthy
Factoring Has Been a Growth Market
The rate of market growth for factoring was only 0.5% in 2008. Limited factoring growth in 2008 was consistent with past economic downturns. Factoring receivables experienced an increase of 9.2% in 2010.
Over 90% of businesses still wait for 30, 60 or 90 days to be paid. 73% factor on a non-recourse basis in which the lender assumes both the title and the risk of default.
This graphic should help you decide if AR or PO financing is right for you: