Funding Through Future Sales: An Introduction to PO Financing and Invoice Factoring
Whether you’re a CPG company, restaurant, or even a farm, you need to keep a steady flow of operating capital to make sure you can produce your product to sell. But every now and then, if all is going well, you can a massive boost: a large order that will help your business to expand. At first, this is the best news you can get – unless you don’t have the capital available to make the product. There are many ways to fund the growth of your business, but two tools that should be a part of an entrepreneur’s arsenal are Purchase Order (PO) Financing and Invoice Factoring.
Purchase Order Financing
Definition: PO Financing is when one company pays, or opens a line of credit for, the supplier of another company for goods that were ordered in order to fulfill a product or job for a customer.
Layman’s Terms: If Walmart gives you a purchase order for $2m worth of your world famous jam, you’ve got to figure out how to get $1m of jam jars from the jar supplier in order to fulfill the order. If you don’t have that cash on hand, a financing company can pay the jar supplier for you. They get paid directly from Walmart to get their money back, with some interest on top.
Why Do It? Some of the reasons are obvious. If you don’t have enough money, but you want to grow, this is a quick way to get it. Even if you do have enough capital for that particular order, you still might want to look into PO Financing. Particularly for newer companies, it’s can be easier to get access to capital through PO Financing than a more traditional lender because it is backed by actual sales. Additionally, PO Financers focus more on the creditworthiness of the customer, rather than your company. So if you’re actually selling to a Walmart-type retailer, it’s an easy sell to the financing company even as a fledgling startup.
Be Wary: Companies that do PO Financing are not doing it for free. Lenders take a percentage, and it can add up quick. Rates can range between 1.8% to 6% per month, so if you have 90 day terms with customers, that can really take a cut out of your bottom line.
For more about Purchase Order Financing, Fundera gives an excellent in-depth look.
Definition: Invoice Factoring consists of selling your invoices at a discount to a factoring company. They pay the majority of the invoice upfront, and the remainder when they get paid by the end customer.
Layman’s Terms: You just delivered $2m worth of jam to Walmart (great job, by the way). Unfortunately, you have 60 day payment terms with Walmart, and without that money you can’t fulfill the other items in your sales pipeline. You can go to a factoring company and sell them the invoice to get money today. They’ll give you some percentage immediately (maybe $1.5m). Once Walmart pays the bill, they’ll give you another $450,000, bring the total to $1.95m. They’ll keep $50,000, in this case, 2.5%, as the transaction fee.
Why Do It: Cash on hand is king. You can use that capital to continue your growth immediately instead of waiting until those 30 to 90-day payment terms are up. In addition to that, technically, this isn’t even a loan. Since you’re selling your invoices, you don’t have to go through the hoops required for traditional lending. Also, unlike a loan, there is no collateral required to close the deal.
Be Wary: While not as expensive as PO financing, there is still a 1% to 5% fee taken by the factoring company. More than just the fee, if the factoring company is doing the collection themselves, you lose control of customer support during that piece of the transaction. Make sure the factoring company will not hurt your reputation during the process. Lastly, if the factoring company ultimately cannot collect on an invoice, they may be able to turn around and charge you more money because of the failed collection.
For more information about invoice factoring, this overview from Nerdwallet will answer all of your additional questions.
Which is right for you?
Both PO Financing and Invoice Factoring solve the same problem: operating cash flow. Each do it in slightly different ways. If the order is too big for your current cash flow, you may want to look at PO financing to cover your supplier cost. However, if you need that capital for future sales, you may want to save on the fee by choosing the factoring route. Before you make a decision, understand the pros and cons of each option. Biz Journals compares the two side by side, showing you some of the less obvious differences.