Purchase order financing is a form of asset based business financing that business owners and managers utilize to cash flow profit earning opportunities.
A basic overview has the borrower holding a purchase order for delivery of goods to a customer and requires a financing advance against the purchase order to secure and potentially complete the finished goods in question.
In order know if your business could be eligible for purchase order financing, here are some generic requirements to consider.
1. The purchase order needs to be for a commodity good that has an easily identifiable market in terms of asset liquidation pathway and value. The best liquidation plan for most purchase order financiers is the customer list of the borrower. Existing customers are already buying the product from the source so its reasonable to presume that this would be the fastest and easiest way to move the product, especially if a discount was provided.
2. The issuer of the purchase order must be a credit worthy entity capable of honoring the purchase order if it is properly fulfilled. Some lenders will even go so far as having the issuer qualify for accounts receivable insurance before approving financing.
3. The product to be sold must have a profit margin of 20% or higher. In the event of any transactional or repayment issues, the lender will step in and liquidate its security for repayment and because the assets will be forced liquidated, there needs to be some margin in the product to allow for a likely discount under conditions of a forced sale. The second reason that a solid margin is required is to cover the cost of financing. Purchase order financing is not cheap and can range from 2% a month to upwards of 4% a month plus administration fees.
4. If raw material needs to be turned into finished goods, the amount of work required needs to be minor in nature. Lenders don’t want a bunch of money sunk into work in progress that may not be in a sale able form.
5. The supplier of the material that will likely be receiving proceeds directly from the purchase order financing lender, needs to be well established in terms of reputation and financial stability. Typically, a lender will want to see the borrower have some prior dealings with the supplier in question.
6. The issuer of the purchase order must be prepared to pay the lender directly once the goods written in the purchase order have been received by the P.O. issuer. The lender must be paid directly by the borrower’s customer, which is quite standard in asset based lending due to the high levels of leverage and risk involved.
7. If the supplier of goods is from another country, the lender may require a third party inspector to inspect the product during production and loading and have the borrower bear the cost of this activity.
These are just some basic things to consider with purchase order financing. There can be numerous variations to above but this provides a basic overview of what you need to have in place to be able to secure purchase order financing.