Note: This is a guest post by Richard Eitelberg, CPA, and founder/president of Hartsko Financial Services, a 10-year-old purchase order financing firm based in Bayside, New York.Purchase order financing is a valuable financing tool for small business owners and entrepreneurs, which is underutilized because it is misunderstood.
If an enterprise has an excellent relationship with a bank, factor, or asset-based lender — especially when more cash is needed on a short-notice basis — PO financing most likely will not be a necessary tool for business financing. If the business is missing out on an opportunity to earn profit on a transaction because of a lender’s failure to follow through, purchase order financing maybe the only option.
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Many times, this especially rings true for small businesses with questionable financial statements, weak credit scores, a problematic history, perhaps, even a bankruptcy.
The typical small business owner looks for PO financing when there are no alternatives left, as a last resort to preserve a deal with income-earning potential. Often, the purchase order finance firm gets called upon under critical, emergency pressures.
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Why is a purchase order financing firm able to assist when bankers and other lenders have rejected the business?
Because the purchase order financier is NOT loaning money to the business.
It is merely buying the merchandise of the purchase order issued by a credit-worthy company acquiring goods for resale. When the purchase order gets issued, the financier and his client (typically a manufacturer, a supplier, a distributor, a vendor, a reseller, an importer), make a contract with the source that will be producing the goods. The purchase order financier guarantees payment to the source through a “letter of credit” and/or payment, direct to the client’s supplier upon the goods being shipped and arriving properly at their destination.
When the goods get confirmed according to the terms of the purchase order—the purchase order financing firm gets “taken out” either by a third party such as, a receivable lender, a private equity firm, or some source of cash or back-end letter of credit.
PO Financing Details
Generally, PO financing deals run from 30-120 days, for amounts in the range of $50,000-$5,000,000. If a business stood to make a minimum 30% on a deal — the business owner may have to incur between 3-4.5% per month for a finished good transaction, and 5-6% per month for WIP transaction negotiated.
In essence, without laying out any real money for the deal, the business owner has been enabled with this cash flow and an opportunity to earn profits without any use of their funds. The purchase order finance firm has earned fees for putting its funds at a risk — which no bank or other lender would accept.
Another feature is that purchase order financiers generally have abundant knowledge and technical information on how these transactions work, where to go, etc. And they are accustomed to seeing the financing process consummated under distress emergency issues.
Look for a purchase order finance firm that is recommended by one of the two peer review industry associations in this sector: the Commercial Finance Association (www.cfa.com), or the International Factoring Association (www.ifa.org). Generally their endorsement means the firm has been properly vetted, operating with ethics and standards.
For many business owners, it is wise to test drive the purchase order finance process by actually experiencing a deal, even if other financing is available. This way the business owner becomes prepared with a backup facility and a relationship, if their first-choice lender encounters a problem.
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