What is purchase order financing? Everything you need to know

Getting a big order is cause for celebration – as long as you can afford to fulfil it. Purchase order financing, also known as PO financing, is one option if you’re struggling with the cost of handling large orders.

Here’s what you need to know.

Key takeaways

• Purchase order financing allows businesses to pay supplier costs before their clients pay for their orders

• This means companies can avoid financial difficulty when fulfilling expensive orders

• Purchase order financing is available to businesses of all sizes, including startups and SMEs

What is purchase order financing?

Purchase order financing is a type of business loan for companies that need help covering the cost of fulfilling customer orders.

It allows companies to handle high-value orders without creating cash flow problems which could cause financial strain before their client pays. 

Providers of PO financing can cover up to 100% of the costs involved in handling an order. The amount you can borrow will depend on a range of factors, including your company’s creditworthiness. 

In some cases, you may need to provide a personal guarantee, meet a minimum annual revenue or have a purchase order value to qualify.

If you qualify, funds may be available in your account within 24 hours.

How does purchase order financing work?

To take out purchase order financing, you must first have a confirmed order and a clear estimate of how much it will cost to fulfil. If you can cover these costs without emptying your business bank account, that’s great. If not, a PO financing company may be able to help.

In this case, the process typically works as follows:

• You contact a PO financing provider with proof of your order and an estimated cost

• The lender checks your business credit rating and informs you how much it can lend and at what cost

• You receive the funds and use them to pay your supplier, packaging, and any other related expenses

• Once the order is ready, you send it out and invoice the customer

• The PO financing lender collects payment from the customer, deducts any fees and sends you the remaining balance

Purchase order financing – pros and cons

Advantages of PO financing:

• Availability: Small companies and even start-ups can access purchase order financing. It is also available to businesses with lower credit scores, as the capital provided is linked to a confirmed order and repaid by the end customer.

• Speed: PO financing companies can often provide funds within 24 hours if you meet the terms and submit all the required paperwork.

• Growth: This type of finance allows you to unlock your company’s potential by accepting large orders without compromising cash flow.

• Security: Since the lender collects payment directly from your customer, they are responsible for chasing any late payments.

Disadvantages of PO financing:

• Cost: PO financing companies charge monthly fees of up to 6%, which equates to an annual percentage rate (APR) of 50%. This makes it an expensive financing option, particularly if your customer takes a long time to pay.

• Reputation: With PO financing, your customer is aware that you lack the funds to fulfil their order without borrowing. This could make them hesitant to work with you.

• Limitations: While some PO finance lenders cover 100% of order-related costs, others finance only a percentage of the total. Additionally, this type of financing is only available to companies selling physical goods. Service providers in a similar position should consider invoice finance instead.

• Short-term nature: PO financing is a short-term solution designed to fund the preparation of a specific order. For long-term funding, better alternatives include start-up loans and asset-based lending. You can learn more about financing options in our five-minute guides on how to get funding for a business and sources of business funding.

Is purchase order financing suitable for your business?

Purchase order finance is popular with SMEs that lack the cash to cover the cost of fulfilling large customer orders. 

It can be a useful way to improve cash flow as your business grows – especially since the lending checks involved are generally less stringent than those required for many other types of business loans. 

However, this type of finance is only available to companies selling physical goods rather than services.

PO financing is also designed for short-term use and is less flexible than many other forms of business finance, as the funds can only be used for a specific purpose.

If PO financing doesn’t seem like the right fit for your business, alternative funding options to consider include:

• Business loans

• Business overdrafts

• Business credit cards

• Merchant cash advances

• Invoice factoring

• Invoice discounting

• Term loans

• VAT loans

• Asset-based lending

How much does purchase order financing cost?

The monthly fee for purchase order financing typically ranges from 1.8% to 6% of the amount borrowed.

For example, if you borrow £20,000, you can expect to pay between £360 and £1,200 per month in charges, depending on the fee applied.

When selecting a PO financing provider, it’s important to check:

• How much of the purchase order value can be funded

• How quickly funds will be made available

• What happens if your customer fails to pay the lender