The problems affecting businesses trying to scale can be difficult to navigate. When a large new purchase order comes through, it should be a cause for celebration — but often this brings further problems on the supply chain side. When a lack of available inventory makes it so a company can’t fulfill an open purchase order, the right financing helps it deliver by paying manufacturers to produce and ship a product. While the funding provider covers these costs, the business retains its existing capital stack, leaving time, energy and valuable cash to focus on scaling up.
Purchase order financing for startups, small businesses and other enterprises can be a powerful tool. Yet it is important to know precisely how it works and to understand which businesses it makes sense for over others. To help you decide if it is the right option for your business, this explainer article will briefly break down how it works and why it suits some companies better than others.
What is PO Financing?
Purchase order financing (also known as ‘PO finance’ or ‘PO funding’) is a funding option used by businesses where a third party pays a company’s suppliers to fill that company’s open customer orders (purchase orders).
When customers open a purchase order, they commit to buying a product, but filling this order through a supplier means using existing capital to pay for manufacturing and shipping. The problem is that liquid cash is not always easy to access. Companies of many sizes often find that they don’t have enough money to fulfill every order that comes their way.
This creates problems when it comes to business growth. Turning down a purchase order is rarely a positive thing, but it feels especially hard when a company feels unable to fill a large purchase order because they do not have enough liquid capital at the time. The business loses out on a valuable sum that could be key to reaching the crucial next stage in its growth. That’s where purchase order funding is considered — a third party steps in to help the business meet existing demand. This way, owners can gain more revenue and focus attention on other aspects of the business — such as sales, marketing and product development — in order to scale up.
How it works
If a company decides to seek purchase order financing once a new customer order has come in, they can reach out to the funding provider to help them deliver. Here’s what you can expect from the process:
- Business submits application for PO funding
- If approved, funding provider pays the supplier to complete the order
- The manufacturer ships the product to the customer
- Funding provider invoices the customer
- Customer sends payment directly to funding provider
- Funding provider deducts the fee from payment before sending remaining balance back to the business
Is PO Financing right for my business?
Purchase order financing provides straightforward access to capital in the short-term, giving a business a competitive edge that lets them measure against bigger brands without relying on supplier credit. This opportunity to take care of overhead costs and concentrate on growth is appealing to many companies of different sizes, but it is not suited to every single business type. There are important factors to consider when pursuing this option.
How to decide if PO Finance is right for you
1) Order size
To start, do you have enough inventory to meet demand? If, for example, a small t-shirt business has seen a sharp influx in order volume from a customer, going from twenty t-shirts to five hundred, this requires a quick response to scale up manufacturing. In this scenario, a lack of liquid capital is often seen as the most important obstacle to fulfilling the order. Purchase order funding pays the manufacturer directly to produce a much higher volume of product than they are used to. If the order volume is comparatively small, however, a better option is to use existing capital to fulfill the order.
2) Business type
Cash flow shortages are often what bring companies to use PO Finance, but as we’ve already mentioned, this problem can apply to a range of different businesses. The types of operations that are well-suited to this funding option will typically share other characteristics.
Startups and other types of businesses experiencing rapid growth are a strong example: these need to quickly purchase more inventory to meet increasing demand in a short period of time, and so are well placed to benefit from PO Finance. If your business has a narrow profit margin, however, the overall cost of business will leave you in a similar position (having a limited capital stack) as soon as you repay the funding provider.
Purchase order financing also helps companies adjust their supply chain to spikes in demand. A boutique swimwear brand, for example, would typically experience a large volume of orders over summer compared to other months. In this scenario, the company does not have to spend its capital all year round on producing apparel that is only in demand for four months in a year.
Instead, it can pursue marketing efforts, for example, growing brand awareness in the knowledge that a funding provider can account for manufacturing costs in the short-term when demand starts to grow. If sales are steady throughout the year, on the other hand, you will have a reliable cash flow that can support the purchase of further inventory without additional funding.
Although PO funding is pursued by a range of business sizes, small to medium-sized businesses are especially well-placed to benefit since they will have limited equity to sell in order to fund supply in the short term. When a business owner sells the value of a company to investors in the short-term to meet demand, the long-term impact will be a diluted power structure and less control for the business owner — making PO funding a viable, valuable solution.
For many businesses, PO financing is an easier alternative to a traditional bank loan, but that does not make it equivalent to an instant cash injection. Successful applications with little to no inaccuracies can benefit from a quick turnaround, but in an extremely urgent situation — for example, a 24-hour turnaround— purchase order financing is unlikely to help a business fulfill an order. The funding provider has to conduct its due diligence, including a credit check, before it can release funds to the supplier.
Can PO Financing help you scale?
With easy and flexible access to capital, your business can transition from being perpetually on the cusp of growth to a viable, scaling company delivering on its true potential. There are many reasons to pursue purchase order financing as a way to grow your business, often due to a sudden spike in demand or a chronic lack of available capital. It must not, however, be seen as a one-size fits all solution for any business.
We work with ambitious startups that need a little more room to grow, seasonal businesses with an uneven cash flow, and many more driven companies that don’t want to lose their momentum due to a lack of inventory. To us, it’s not just a matter of credit score: we provide a flexible, holistic approach to all of the businesses we partner with. To find out more about if Setscale’s interest-free solution can work for you, fill in a request form today. If you’re ready to scale, so are we.