What is Purchase Order Finance and how is it Different from Other Factoring Products?

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What is Purchase Order Finance and how is it Different from Other Factoring Products?

Updated: 31st July 2021

If you’ve ever been stuck in the middle of a business transaction, unable to move forward due to cash flow restrictions, you may find that purchase order finance can help you meet the gap in working capital.

This type of invoice finance differs from factoring and invoice discounting. Its fundamental distinction is the stage at which money is advanced from the lender, and on what basis cash is released.

To explain further, let’s have a look at how other ‘standard’ factoring solutions work:

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Invoice factoring and discounting

These two products enable you to access regular amounts of working capital once your customer has received their product order, or the service you offer. When work is complete, you invoice them as normal and receive a cash lump sum from your lender.

It is low risk as far as the lender is concerned. The premise behind invoice factoring and discounting is the release of cash after full delivery of customer orders. Once the customer has paid in full, your lender will send you the remaining balance minus their fees.

This is the basic principle of factoring and discounting. So how does purchase order finance compare, and how can you decide whether it would be suitable for your business?

Who uses purchase order finance, and how does it work?

Companies trading internationally, or those taking on government contracts, could benefit from purchase order finance. International trade often involves working with a third party largely unknown to businesses, simply due to geographical circumstances.

Government contracts are potentially extremely fruitful, but the demands of a large contract introduce significant financial risk to the business.

Once a purchase order has been accepted by your business, it becomes a legal contract, and this is where purchase order finance removes some of the financial pressures of fulfilling the order.

This is a short breakdown of how it works:

  • You receive a purchase order from an existing or new customer, requiring ready cash to fulfil all of its requirements - these could include hiring additional staff and purchasing goods.
  • Because your supplier works on a cash-on-delivery basis, the lender advances a significant proportion of the final invoice amount – generally between 80% and 90%.
  • This allows you to fulfil the order without depleting cash reserves or entering into long-term bank borrowing.
  • Once the work is complete, your lender collects payment on the invoice, and remits the balance to you after taking out their fee for the service.
  • It is generally product re-sellers and distributors who use this type of finance.

Is your business eligible to work with this type of financing company?

Purchase order finance comes with significant risk to the lender, and because of this costs may be higher than with a factoring arrangement. Although your own business won’t need to have an impeccable credit history, detailed checks will be carried out on your customer to ensure that the invoice will be paid.

Any previous business transactions with the customer may also be scrutinised by the lender in an attempt to assess their risk. They’ll be looking for a strong trading history ideally, but from their point of view it is imperative to correctly judge their level of risk on each purchase order finance arrangement.

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Benefits of entering into a purchase order finance agreement

  • You can avoid the temptation to take on orders beyond your financial capacity, and reduce the chances of overtrading
  • Your credit rating need not be high as it is your customer that must be creditworthy
  • It offers you the opportunity to grow your business without excessive risk
  • Lending can be scaled up or down as necessary
  • It’s a quick way to access working capital when compared with traditional bank lending
  • Existing reserves of cash are not depleted
  • You don’t need to decline larger or unexpected orders, keeping your business reputation intact
  • It’s a flexible, short-term borrowing option

Real Business Rescue has long-standing contacts in this niche area of finance, and can put you in touch with specialised purchase order lenders. We offer professional guidance on whether this type of finance is right for your business – call one of our team for a meeting to discuss your needs and objectives. 

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