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Purchase Order Financing

Tuesday, December 07, 2010   By Mike Reddy

 

One of the ironies in business is that if you want to increase revenue, sometimes you need to borrow money. The reason is simple: growth is expensive. Suppliers will almost always require payment before you have received money from sales.

Managing cash flow is the toughest job in any business. The cautious business that relies on income to fund expansion rather than borrowings will limit the maximum speed of growth, as income will always lag behind expenses. In most businesses, particularly in manufacturing, the only way to increase income substantially is to increase outgoings - on materials, manufacturing, transport and other costs of sale. But where does a business get the credit to tide over the delay between paying for goods to be made and sold, and receiving the income from them?

Unfortunately, credit has remained difficult to come by since the global financial crisis. Many of the traditional avenues for obtaining credit, such as bank or private loans, have become too restrictive or expensive. One alternative is purchase-order financing, where a lender steps in to cover the cost of manufacturing and takes a percentage directly from sales.

The advantage for a small business is that it can take orders much larger than it could otherwise afford. A supermarket chain could order 100,000 units of hand soap from a boutique supplier. The purchase-order lender evaluates only the credit history of the buyer, in this case the supermarket chain. If the chain shows that it pays its bills on time, the lender pays the soap manufacturer directly. The soap is shipped straight from the factory to the supermarket chain and payment is received by the purchase-order lender, which passes on the margin to the boutique supplier.

ADVANTAGES

  • A business with cash flow problems can gain easy and fast access to money based on the financial reputation of a large customer.
  • The loan is effectively debt-free and avoids the time involved in applying for a bank loan, and the possibility of rejection.
  • A business never has to turn down an order because it doesn’t have enough money to cover operating costs.
  • The purchase-order lender takes care of collection.
DISADVANTAGES
  • Purchase-order lenders can charge high fees for the convenient access to credit.
  • If the customer insists on payment terms of 60 or 90 days, a second lender may be required to pay the purchase-order lender upfront. The factor lender will pay an invoice at a discount and collect the full amount at a later date with the original customer.
So it’s worth considering other finance options before considering a purchase-order loan. But in the absence of a viable alternative, a purchase–order loan can be the difference between accepting a large order and turning it down.

 


Mike Reddy is a Chartered Accountant, business coach and advisor helping businesses in Sydney, Melbourne, Brisbane and Gold Coast to easily increase their profits and cash flow. He is currently President of the North Sydney Chamber of Commerce, a Regional Councillor for Sydney North East and a member of the Institute of Chartered Accountants Sydney leadership team. As well as advising businesses, Mike presents business development seminars and webinars and is regularly contacted by the media to comment on small business matters. You can connect with him on Facebook, Twitter and Google+.