Many business opportunities come with an associated challenge. For most entrepreneurial businesses, the greatest challenge is financing the business opportunities created by your sales efforts. What are your options if you have a sales opportunity that is clearly too large for your normal scale of operations? Will your bank provide the necessary financing? Is your business a startup or too new to meet the bank’s requirements? Can you tap into a commercial real estate or home equity loan with insufficient time to conclude the transaction? Do you decline the order? Fortunately, there is an alternative way to meet this challenge: You can use Purchase Order Financing & Letter of Credit financing to deliver the product and close the sale.
What is purchase order financing?
Purchase order financing is a specialized method of providing structured working capital and loans secured by accounts receivables, inventory, machinery, equipment, and/or real estate. This type of funding is excellent for startup companies, refinancing existing loans, financing growth, mergers and acquisitions, management buy-outs, and management buy-ins.
Purchase order financing is based upon bona fide purchase orders from reputable, creditworthy companies or government entities. Verification of the validity of the purchase orders is required. The financing is not based on your company’s financial strength. It is based on the creditworthiness of your customers, the strength of the commercial finance company funding the transaction, and in most cases, a letter of credit.
What is a letter of credit?
A letter of credit is from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. If the buyer cannot make payment for the purchase, the bank is required to cover the full amount of the purchase. In a purchase order financing transaction, the bank relies on the creditworthiness of the commercial finance company to issue the letter of credit. The letter of credit “backs up” the purchase order financing to the supplier or manufacturer.
Is purchase order financing appropriate for your sales program?
The perfect paradigm is a distributor buying products from a supplier and shipping directly to the purchaser. Importers of finished goods, exporters of finished goods, out-source manufacturers, wholesalers, and distributors can effectively use purchase order financing to grow their businesses.
Is purchase order financing appropriate for growing your sales orders?
Purchase order financing requires you to have management expertise- a proven track record in your particular business. It would be best if you had bona fine purchase orders from reputable firms that can be verified. And it would be best if you had a repayment plan; often, this is from a commercial finance company in the form of accounts receivable or asset-based financing.
You should have a gross margin of at least 25% to benefit from purchase order financing. Sellers of services or commodities with low margins, such as lumber or grain, will not qualify.
The bottom line decision for purchase order financing:
It can take two or more years to develop a profitable business. Banks generally base their lending limits on a business’ performance for the past two or three years. Purchase order financing, combined with letters of credit and/or accounts receivable or asset-based financing, can give you sufficient funds to cover your operating costs, financing costs and still realize significant profits. If you qualify for purchase order financing, you can grow your business by taking advantage of large purchase orders and eventually qualify for bank financing.