Purchase order financing guide

For small businesses struggling to fulfil a large order, purchase order financing could be a solution.

Small businesses, particularly during the early stages of growth, may lack the funds to handle a large order from a customer.

Supplies, packaging, and other expenses need to be covered, and although the order might be worth a lot of money, you won't receive payment until after you've delivered it, which can cause a cash flow problem and could slow down the growth of your business.

That's where purchase order financing (PO financing) comes in.

What is purchase order financing and how does it work?

The difference between PO financing and invoice financing is that with PO financing you’re able to get the finance ahead of the delivery of goods, but with invoice financing, the goods would need to be delivered before the invoice is settled.

The process of how PO financing works can vary depending on the finance company, but a typical process follows these steps:

1. You receive a purchase order from a well-established and financially stable customer, but you do not have all the funds to pay your supplier and deliver the order
2. You contact a finance company which agrees to provide PO financing of up to 100% of the supplier's costs
3. The finance company provides the finance according to the agreed terms you use to pay the supplier
4. You deliver the order, send an invoice to the end customer and the purchase order financing company
5. The purchase order financing company collects payment from the end customer
6. The purchase order financing company sends the remainder of the end customer's payment to you after deducting their fees.

Pros of purchase order financing

Advantages of PO financing include:

Allows you to take on large orders

PO financing allows you to grow your business as you can accept larger orders that you would otherwise have to turn down due to a lack of funds to cover supplies and other costs.

Wide eligibility

Unlike other funding options that only established or larger businesses can access, PO financing is available to smaller businesses.

Even a business with a poor credit rating may be able to get PO financing because the finance company bases approval on the creditworthiness of your supplier and client rather than your business.

Quick to access

If you have a purchase order from a reputable company, the financing company will often approve applications quickly and often faster than traditional banks.

You can receive the money as soon as 24 hours after you apply.

No need to manage the payment

Your business does not have to chase payment or be at risk of non-payment because the lender is responsible for ensuring the customer pays for the order.

Cons of purchase order financing

The downsides to purchase order financing include:

High fees

PO financing can be expensive due to the fees charged by finance companies.

Typical fees are between 1.8% and 6%.

Lack of flexibility

PO financing lacks the flexibility of a traditional loan because you can only use it to pay for the cost of fulfilling the order for which the funding has approval.

Perception of your business

As they deal directly with the lender, the customer may not like that you are selling their invoice, and they could become concerned about the financial health of your business.

As a result, they may decide not to buy from you again.

Alternative finance options

If PO financing doesn't work for your business, other finance options include:

• Loans: an amount of money you pay back with interest over an agreed period. Loans can be short-term or longer-term, and either secured or unsecured.
• Overdraft: a line of credit that allows you to withdraw more than the funds you have available in your business bank account. Overdrafts can provide a safety net for unexpected expenses and short-term cash flow issues.
• Credit cards: a credit card allows you to make business purchases and payments using a line of pre-agreed credit.
• Leasing and hire purchase: this is finance that lets your business buy equipment, machinery, and vehicles you might otherwise be unable to afford. Leasing allows you to use it as an asset in exchange for rental payments. Hire purchase is when you agree to buy an asset from the lender over a specified period.
• Invoice financing: also known as invoice discounting and factoring, invoice finance allows your business to use its invoices and accounts receivable as security for funding.
• Asset-based lending: this finance uses assets on your balance sheet as security against lending. Assets include stock, machinery, equipment, property, and intellectual property.

Find out more about business financing in our guide.