What Is Purchase Order Financing?

As your business starts to grow, you may encounter clients with orders that you can’t fulfill immediately. Completing these orders could be huge for your business—both financially and for your reputation—but you might not have the resources and funds at that stage. 

This scenario is very common—especially for new businesses—and it’s where purchase order financing comes in. Learn more about the process of seeking out funding to help fulfill orders. 

What Is Purchase Order Financing? 

A purchase order (PO) is an agreement to pay for goods or services. Companies of all sizes, from multi-billion dollar manufacturers to small bakeries, use purchase orders to protect themselves and their customers. 

However, there are times when a purchase order is too large or too expensive to fulfill. When this occurs, the organization needs to seek out financing options to pay suppliers so they can hold up their end of the purchase agreement. A common solution to this problem is purchase order financing. 

Going back to your high school economics class, think about this in terms of a lemonade stand. It’s fine to fulfill 1 lemonade cup order for a dollar, but what happens when someone orders 1,000 cups of lemonade and promises to pay you upon delivery? You don’t have the money yet for enough lemons and sugar to fulfill the order.

With PO financing, a lender can help to ensure the order gets fulfilled—protecting your customer, your supplier, and everyone else involved in the process. 

Purchase Order Funding Is Not Working Capital

Before diving deeper into PO financing, it’s important to consider what this form of funding isn’t. Purchase order financing is not a working capital loan. You can’t bring a purchase order to a lender and receive cash to fulfill a major order. One of the biggest misconceptions about PO financing is that business owners simply receive the loan like they would with any other source of funding. However, it’s more complicated than that. 

Let’s review what purchase order funding is so you can understand what it’s not. 

How Purchase Order Financing Works

Purchase order financing works when you bring in a lender to mediate between you, your supplier, and your customer. Here are a few steps that explain how this process works:

• You’ll provide a clear purchase order to your lender to review. 
• If the lender approves the loan, they’ll reach out to your supplier to discuss the materials and manufacturing. 
• Your lender will pay your supplier for the work.
• Your supplier fulfills the order and presents it directly to your customer (not to you, the business owner). Their role in the process is over. 
• You’ll send an invoice to your customer to pay for the order.
• The customer pays the financing company, not you. Your lender will take their side of the fees and send you the balance.

Throughout each of these steps, the lender is involved with the purchase process. They need to make sure the order is fulfilled and the customer is happy—or the invoice won’t get paid and they’re not getting their money. 

If you want to return to the lemonade stand metaphor again, it’s like your mom going to the store and making the lemonade for you but letting you have the profits only after she delivers the order to the customer.    

What Do Lenders Look for in PO Funding? 

If you are considering PO financing, there are a few things you need to know. Having the right information beforehand can make the loan process easier and bring you closer to approval. 

First, purchase orders are mandatory to receive PO funding. Oftentimes, business owners mistakenly request funding when a PO is about to come through or when they’re responding to a proposal. A lender won’t fund your order unless the customer has already submitted the order. 

The next thing to know is that experience matters. Lending to startups can be risky. Startups don’t have a track record of delivering goods and might not have a strong relationship with suppliers. If your business has been operational for a few years and can prove its success, more lenders will want to work with you. 

Finally, you need to turn a profit on the goods. Many purchase order financing companies require at least a 30% profit margin on any project they agree to fund. This ensures that the lender can get paid, and the company still makes money in the process. 

If you plan to work with a PO business to get funding, make sure you read their requirements carefully. A good lender will explain clearly what they need before you start the application process. 

Consider Multiple Funding Options for Your Business

PO financing is only 1 way to fulfill a major order for your business—there are other ways to get short-term loans and lines of credit to scale your production quickly. Each of these options has its pros and cons in relation to your business. Learn more about your business financing options through Lendio. Visit our online lending center to determine the best way to access the capital you need.