What Is Purchase Order Financing and How Does It Work?

Purchase order financing provides a financial solution for businesses when working capital is insufficient to fulfill customer orders. It bridges the financial gap between receiving a confirmed order and delivering goods. This short-term funding allows businesses to accept larger customer demands without depleting cash reserves. It supports growth by providing necessary upfront capital.

What is Purchase Order Financing?

Purchase order financing is a short-term business funding where a third-party financier pays a supplier directly to cover the costs of goods needed to fulfill a customer’s confirmed purchase order. A purchase order acts as collateral, representing a commitment from a creditworthy customer to buy goods. This helps businesses procure inventory or raw materials when they lack immediate cash flow. This is a form of non-dilutive working capital, meaning a business does not give up equity in exchange for the funds. It is designed for transactions involving tangible goods, such as those sold by wholesalers, distributors, importers, or manufacturers, rather than services, and its primary purpose is to enable a business to complete a sale it otherwise couldn’t afford, ensuring timely delivery to the customer.

How Purchase Order Financing Works

Purchase order financing begins when a business receives a confirmed purchase order. This order indicates a definite sale and forms the basis for the financing request. The business then approaches a purchase order financing company, submitting the purchase order and a supplier cost estimate. The financing company evaluates the transaction, focusing on the customer’s creditworthiness and supplier reliability.

Upon approval, the financing company pays the supplier directly for the goods, often covering up to 100% of the supplier’s costs. This payment allows the supplier to produce or release goods, which ship directly to the customer. Once the customer receives goods, they pay the financing company directly. After receiving payment, the financing company deducts its fees and advanced amount, then remits the balance to the business. This process allows the business to fulfill large orders, maintain cash flow, and profit from sales without substantial upfront capital.

Who Can Use Purchase Order Financing?

Purchase order financing is beneficial for businesses with large, confirmed orders but insufficient cash flow to pay suppliers. It allows growing companies experiencing rapid expansion to scale operations and increase revenue without working capital limitations. Startups or businesses with limited operating history, often ineligible for traditional bank loans, find this financing accessible. The focus shifts from the business’s credit history to the customer’s creditworthiness and supplier reliability.

Companies with seasonal demand or sudden large orders can leverage purchase order financing to meet customer needs without straining finances. This funding is suitable for businesses that sell physical products, such as manufacturers, distributors, wholesalers, importers, and exporters. It allows these businesses to accept significant orders and acquire inventory, fostering growth and maintaining customer relationships.

Understanding the Costs and Requirements

Costs are typically structured as a percentage of the financed amount, charged monthly or per-30-day. Fees commonly range from 1% to 6% per month, varying by transaction size, customer’s creditworthiness, and financing duration. Some financing companies may include additional charges, such as origination or administrative fees. While monthly rates may seem low, the annual percentage rate (APR) can be significantly higher, sometimes ranging from 20% to over 50%. The total cost is also influenced by how long it takes the customer to pay their invoice, as fees often increase with extended payment periods.

Eligibility for purchase order financing hinges on several requirements. A primary condition is a confirmed, non-cancelable purchase order from a creditworthy customer, as the financier relies on their ability to pay. The transaction must involve tangible goods for resale, not services or raw materials requiring extensive manufacturing. Financiers require a sufficient profit margin on the order, commonly at least 15% to 25%, to ensure profitability after financing costs. The supplier must be reliable, with a track record of delivering goods on time and to specification, and minimum transaction values, often starting from $50,000, may apply.