Purchase Order Financing
Companies that buy goods from a supplier in order to sell them to an outlet that has already ordered them can use Purchase Order Financing if their working capital budget is stressed. The goods purchased from the supplier may be finished goods or raw goods that the company completes before shipping them to the outlet that ordered them.
The following is an example:
Ackmee Doohickey Company receives a purchase order from Big Ole Mart for 1,000 doohickeys. Sales have been good but got even better quickly. Ackmee only has 400 doohickeys in stock. If Ackmee tapped into their working capital to buy 600 more doohickeys from their supplier, it would give them a cash flow problem. If Ackmee doesn’t provide 1,000 doohickeys to Big Ole Mart they will lose all future sales to them. Solution – short term Purchase Order Financing.
Here is how purchase order financing works.
- Your customer issues your company a purchase order for goods.
- Your company secures an agreement for the goods with their supplier.
- Your company arranges financing from a PO lender.
- The PO lender verifies the purchase order and confirms the supplier’s creditworthiness.
- The PO lender pays your supplier for the goods.
- Your supplier produces the goods and ships them directly to your customer.
- Your customer then:
- Pays the PO lender upon delivery. The PO financier forwards the profit to your company which is the purchase order amount minus the loan amount and PO discount fee (usually around 1% to 5% of the purchase order). So if the purchase order sold to the buyer was for $100,000 and the supplier cost was $80,000 and the PO discount fee is 3%, your company would receive $17,000.
- Issues the PO lender a receivable. In this case the receivable is factored. The Factor would also charge around a 3% discount fee for a receivable 30 days out. The PO lender then receives payment from the customer in 30 days. They then forward the profit to your company which is the purchase order amount minus the loan amount and PO discount fee and factor discount fee. So if the purchase order sold to the buyer was for $100,000 and the supplier cost was $80,000 and the PO discount fee is 3% and the factor discount fee is 3%, your company would receive $14,000 after the PO lender is paid.
That’s it. You have profited $14,000 to $17,000 where you would have had nothing before PO Financing. Don’t lose that next big deal because of a lack of working capital.