This is one of the most expensive and risky forms of financing. In this arrangement, you will assign your purchase orders to a third-party lender. The third party will be in charge of billing and collecting on the purchase orders. Usually this happens in cases where the company requires cash to manufacture orders.
You would use purchase order financing to pay your suppliers, laborers, and other business expenses to produce goods or bring services that you have not yet delivered.
The finance company will look at your business, your customer’s business (to ensure that they can pay for the products), and the ability of your supplier to manufacture the merchandise for every transaction. The finance company will also look at the transaction itself—all parties must make money from the transaction.
Purchase order financing can be done for finished products and non-finished products:
Finished products: These go directly from your supplier to your customer; you do not take direct possession.
Non-finished products: In this case, you take possession of the products in a raw or semi-finished state to process them and sell the final product to the customer. Non-finished products are harder to finance.
Cost of Purchase-Order Financing
You can incur very high costs if you are factoring your receivables and use purchase-order financing. Total fees can range from 10 to 30% or even more if factoring and purchase-order financing is involved.
Benefits of Purchase-Order Financing
- It provides funding for the cost of goods to be sold (manufacturing costs).
- It is a good alternative if you do not have access to bank loans.
- It allows your company to handle bigger orders.
- It helps you secure better prices from suppliers.
- It is connected to the life of the transaction; it does not increase your debt.
Disadvantages of Purchase-Order Financing
- It is more expensive than other forms of financing.
- It requires finding and researching a lender that is knowledgeable in your industry.
- It is a type of financing that is hard to obtain. A business owner would need to have a certain relationship with the lender or the business should show that it has been in operation for a while and knows what it is doing!