There are moments in business when large orders are received by small product wholesalers. It is one of the biggest challenges to satisfy an order that is beyond their capabilities to fulfill all at once. The risk of not being able to fulfill the order means they may lose the customer to their more financially able competitor. So what do they do? This is where purchase order financing comes in. The business will need to get financing so that it is able to handle large orders that are beyond the business capability to process.
The purchase order financing helps small companies with large orders to pay their suppliers. The purchase financing company usually pays the supplier directly by direct deposit or letter of credit in case the payment is to be made overseas. The payment is for the supplier to manufacture and deliver the goods. By making this payment on behalf of the business, the purchase order finance has made it possible to cater for the order and thus secure the revenues. The transaction is settled once the customer pays for the goods delivered. This is a very simple and straightforward solution that can be applied any time the business has an order which exceeds its financial capabilities.
There is, however, criteria that an order must fulfill for purchase order financing to be granted. These include:
(i) The order needs to be for a minimum of $50,000 though some exceptions can be made.
(ii) The purchase order must not be bound by a policy to not be cancellable.
(iii) The buyer placing the order must have good commercial credit to ensure they are able to pay once goods are delivered.
(iv) The transaction being made must involve finished goods.
(v) The value of the transaction must have a minimum gross margin of 25%, although the percentage can vary.
Due to the nature of purchase order financing, most business entities use it to grow their business and build the balance sheet. Since purchase order financing can guarantee growth in most instances, it is used as a stepping stone to grow enough to be able to access the more conventional lines of credit. The rates of purchase order financing are based off a number of factors which include;
– The size of the transaction
– The length of time that it takes to settle
– The general risk
This method of obtaining funds for SME is very beneficial because it provides the businesses with a much-needed source of financing to be able to pay their suppliers and therefore maximize the opportunities they get from satisfied clients. This method of financing also offers a lot of flexibility and enables businesses to grow rapidly without diluting their equity.