What Is PO Finance and How Does It Work?

Purchase order (PO) finance provides a financial solution for businesses selling physical goods. It helps companies bridge the gap between receiving a confirmed customer order and paying suppliers for materials or products. This enables businesses to fulfill larger orders they might otherwise decline due to insufficient cash flow, supporting growth and operational continuity. PO finance focuses on the value of pre-sold goods, providing a timely infusion of capital to facilitate transactions.

Understanding Purchase Order Finance

Purchase order finance provides working capital to businesses with secured customer orders but lacking immediate funds for supplier costs. It functions as an asset-based financing solution, using a valid purchase order from a creditworthy customer as primary collateral. This differs from traditional loans, which often rely on the borrower’s credit history or other assets. Its purpose is to enable businesses to procure inventory or materials for large orders, preventing lost opportunities due to cash flow constraints.

This financing is commonly used by businesses that resell products rather than manufacturing them from scratch, such as distributors, wholesalers, resellers, and import/export companies. It is particularly useful for those experiencing rapid growth, seasonal demand spikes, or limited cash reserves with substantial order requests. Businesses dealing in tangible goods are ideal candidates, as PO finance does not apply to service-based businesses.

The Purchase Order Finance Process

The process begins when a business receives a confirmed purchase order from a customer for goods. The business then approaches a PO finance company with this order and a supplier estimate for the goods’ cost. The finance company conducts due diligence, assessing the end customer’s creditworthiness, the supplier’s reliability, and the purchase order’s viability. This evaluation determines the risk and funding terms.

Once approved, the PO finance company directly pays the business’s supplier for the goods, often covering up to 100% of costs. Payment can be made via direct cash or a letter of credit, guaranteeing payment upon fulfillment conditions like proof of shipment. The supplier then produces or acquires the goods and ships them directly to the end customer, streamlining delivery. This direct shipment reduces the handling burden on the borrowing business.

After the customer receives the goods, the business invoices the customer, often sending a copy to the PO finance company. The customer then remits payment directly to the PO finance company. Upon receiving payment, the finance company deducts its pre-agreed fees and the advanced amount. The remaining balance, representing the business’s profit, is then transferred to the business.

Key Considerations for Businesses

When evaluating purchase order finance, businesses should consider its suitability. This solution suits companies with consistent, large customer orders for physical goods, especially if they have limited working capital or are experiencing rapid growth. Businesses with high gross profit margins, ideally 20% to 30%, are better positioned to absorb financing costs. It is also more appropriate for businesses that primarily resell finished products rather than those involved in extensive manufacturing.

The purchase order’s characteristics are also important for eligibility. Finance providers prefer non-cancelable purchase orders from creditworthy customers, as their ability to pay is a primary factor. Orders should be for pre-sold, tangible products and not involve consignment or guaranteed sales terms. Some lenders may prefer transactions with a minimum sale price, potentially around $50,000, for cost-effectiveness.

Costs typically involve a percentage of the purchase order’s value. Fees usually range from 1% to 6% per 30-day period or month, increasing if the customer takes longer to pay. Factors influencing the fee rate include order size, customer creditworthiness, and expected payment time. While costs can be higher than traditional bank loans on an annualized percentage rate (APR) basis, PO finance offers speed and accessibility, valuable for time-sensitive orders.

Initiating a PO Finance Application

Businesses interested in purchase order finance must gather specific information and documents. A primary requirement is a copy of the customer’s purchase order, detailing quantities, pricing, delivery dates, and payment terms. Supplier information, including their invoice or pro-forma invoice outlining goods cost and payment terms, is also necessary. This helps the finance provider understand transaction specifics and required funds.

Applicants typically provide general business information, such as legal structure and Employer Identification Number (EIN). Financial statements, including profit and loss statements, balance sheets, and cash flow documents, are commonly requested to assess financial health. Information on customer creditworthiness and existing contracts with customers and suppliers may also be part of due diligence. The application process involves submitting these documents for review, with initial feedback sometimes provided within 24-48 hours.