4 Things to Know About Purchase Order Financing

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There are all kinds of challenges that businesses can face. Some of them seem insurmountable at times. However, if you’re creative and persistent, you should succeed, even in a tough economy.

One of the stiffest challenges that a business can face is ongoing cash flow problems. If you don’t have ready cash for operating expenses, then the whole system breaks down. That’s why we’re going to talk about purchase order financing, a technique that might help your struggling business.

What is Purchase Order Financing?

Before we get into some ways purchase order financing can fuel business growth, let’s define the term, so you know exactly what we mean. Purchase order financing:

  • Is a fairly common funding strategy
  • Is when you pay a supplier directly for product orders

With purchase order financing, you find yourself a lender. That might be an entity like a bank or credit union.

You strike up a working relationship with them. To do that, you’ll need to show them your financial records indicating steady growth and solvency.

Then, if you get a sudden product order surge, you can get the money from this lending institution. You can now take advantage of larger orders and cash in, even when you’re low on funds.

There are Three Entities Involved

With purchase order financing, there are three entities involved. They are:

  • The business owner
  • The purchase order financing lender
  • The supplier

If you don’t have a dependable supplier for whatever you make, then there’s not much point in approaching the purchase order lender. There’s also no need to go through this process unless your product demand increases.

If you’re not certain that you need more of your product, you don’t need to approach the lender, nor do you need to ask your supplier to ramp up production.

You can predict some order upticks based on things like a celebrity plugging your product or a marketing campaign you’re running. However, some customer demand increases happen unexpectedly, and that’s often when you need purchase order financing the most.

Reasons to Set It Up

There are multiple potential reasons why you may choose to look into this possibility for your business. Probably the most prominent one is that if you have this financing in place, or the ability to do it, then you can take on bigger orders.

If there’s a sudden product demand, and you can’t meet it, then that hurts your business. On the other hand, if you’re sure that you have the financing in place and ready for you, that means real growth potential. This is one of the business expansion plans that many company owners feel is the lowest risk and the most realistic.

The other reason we should mention to set up this sort of financing is that if you do this, you don’t need to take out a short-term loan. Shorter-term loans usually come with predatory, exorbitant rates attached. You want to avoid those if it all possible.

Some Possible Reasons Not to Do It

There are also some possible drawbacks if you go this route. One thing to keep in mind is that if you get purchase order financing, you can only use the money you get to pay for the product order surge, and nothing else.

This is not the case with loans. With business loans, you can use that money for virtually anything having to do with running your company and keeping it afloat. If you want more flexibility, you might opt for a more traditional loan, even if you have to deal with those higher interest rates.

The other thing you should keep in mind is that if you want to use purchase order financing, it only works if you have one supplier. Let’s say that you have multiple suppliers because your products do not come fully assembled. The different components come to you, and then you put them together to make the finished product.

If so, then you can’t use this type of financing. Remember that this is a three-pronged relationship: there’s your company, the lending entity, and the supplier. You can’t add a fourth entity or a fifth.

Overall, this option definitely works wonders for many businesses. If you have unlimited financial resources, you’ll probably never need to use it, but very few companies can say that.

If you’re hungry to expand within your niche this year, then you should look into this strategy. It might be what you need to take your business to new heights.