Purchase Order Funding

How purchase-order financing works:
PO funding is the advance of money to a supplier on behalf of a business — that needs supplies to complete an order from one of its customers. The advance can also be made to a subcontractor for work to be completed on the business’s order. A Funding Source sends the money in the company’s name directly to the subcontractor or supplier; the money is not sent to the business itself.

The advance for PO funding is usually repaid by the end user of the product. For example, the funding source buys the invoice that the business sends to its customer when the product is shipped, which turns this scenario into a regular factoring transaction.

Purchase-order financing can also be used internationally and provides businesses an alternative to wiring funds directly to a foreign supplier. Most overseas suppliers want a down payment or deposit before they begin production. And during the production cycle, the business has to deposit more money periodically until the final payment, which is due upon delivery. This process can stretch the business owner financially. While he wants and needs the larger order, he also needs to pay his regular bills and make payroll domestically.

A factor can issue a letter of credit to the international supplier as assurance that funds are available and will be paid upon completion and delivery of the order. Once again, these advances are repaid by factoring the invoice that
is generated when your client — the small business — ships the end product to its customer.

The pluses and minuses
This type of funding carries a higher cost than factoring because the factor takes on more risk. After all, the product materials haven’t been delivered or the work hasn’t been completed yet. And much can go wrong to disrupt the transaction before the order is complete. For example, the contract or order could be disputed or it could be canceled for many reasons, including an act of war or terrorism.

On the positive side, although the money to fund purchase orders is more expensive, your supplier is paid promptly. This gives you the ability to negotiate better payment terms. In the end, the additional cost of PO funding can be erased by the discount the business gets for early order payment. Also, because the raw materials are delivered faster, your client will need less time to produce its product.

PO funding offers other intrinsic advantages, as well. Typically, the small business has to wait in line behind larger companies before its orders are shipped. Because of the prompt payments, however, you becomes a respected customer. Your phone calls are returned promptly, your orders are taken seriously, and the business relationship with the supplier is elevated to a higher level.