Growing a business is never straightforward. Therefore, it’s important to find ways to increase revenue and liquidity by creating more customer demand. However, meeting that demand can also present challenges. Completing customer orders means spending money on operational costs such as maintaining inventory, manufacturing and sending goods, and administrative tasks.
One way to reduce overhead costs like these is to increase supply chain efficiency. In today’s market, businesses often turn to a range of financing solutions to boost working capital and help them manage their supply chains. While many still turn to traditional bank loans, these often lack flexibility, efficiency, and accessibility.
Two alternative finance solutions that address this issue are purchase order financing and supply chain financing services. Both of these are valuable trade finance tools, but are often misunderstood. Here, we break down what each solution is and who it is best suited for.
What is Purchase Order Financing?
Purchase order (PO) financing is a solution businesses of various sizes use to meet demand. When a customer submits a purchase order with a business, they commit to buying the product which is then manufactured and shipped.
However, businesses do not always have enough working capital to fill the order or, in other cases, using existing capital would put a strain on other aspects of the businesses. For example., instead of pursuing other revenue streams, valuable time and energy is spent on completing these open orders.
With PO financing, a third-party supports the business in financing its supply chain and meeting demand. The funding provider directly pays suppliers to manufacture and ship orders to the customer.
How it works
- Business applies for PO financing
- If approved, the PO financer pays the supplier or manufacturer to complete the order
- Supplier/manufacturer ships the product to the end-buyer
- Business invoices end-buyer
- End-buyer sends payment directly to the PO financer
- PO financer deducts the fee from payment, before sending the remaining balance back to the business
Fast capital access
Conventional bank loan applications can take a long time. PO financing is a suitable option for many businesses who do not have enough time to go through a lengthy approval process that may be unsuccessful.
Forming a relationship with a PO finance can lead to a reliable flexible long-term partnership. PO financing accounts for more than the buyer’s credit score — the finance provider looks at ongoing opportunities, structuring the finance solution according to the specific needs of the business.
PO finance helps businesses manage supply chain capital and maintain a healthy cash flow. It allows them to focus on the big picture and bring in more revenue through other channels, such as marketing, sales and developing new products.
PO financing lets businesses manage their cash flow and supply chain, but this does not apply to all expenditures. While a viable tool for those companies with larger buyers that outsource supply, it will not be able to cover any given ongoing expenditure like a working capital loan. Instead, it applies to only specific transactions and assets.
PO financing typically has a higher annual percentage rate (APR) than a traditional loan. As a result, some argue this option is mainly effective when used with higher margins.
What is Supply Chain Financing?
When filling customer orders, a business often looks to negotiate and extend payment terms if they do not have enough capital to pay their suppliers within the invoice window (e.g. 30, 60 or 90 days). While this gives the buyer more flexibility, it impacts the supplier’s cash flow and can put a strain on the buyer-supplier relationship.
Supply chain finance (SCF) helps solve this problem by letting buyers and suppliers collaborate through a third-party finance provider. The provider assesses the creditworthiness of the buyer, and if they have confidence in their ability to repay, will take on the payment delay and pay the supplier within a matter of days, rather than weeks or months.
How it works
The process is facilitated by an SCF program. The buyer invites the supplier to access an SCF platform, and once the supplier joins, they submit their invoices as usual. The financing company assesses the credit rating of the buyer to evaluate the credit limit for them paying supplier invoices upfront. If the financer approves, the supplier receives payment as soon as the buyer approves their invoice.
- Buyer purchases goods or materials from the supplier.
- Supplier sends invoice to the buyer in the usual manner, with payment due within a set time period (30, 60, 90 days)
- Buyer then approves invoice payment
- Supplier requests advance payment on invoice from supply chain finance provider
- Supply chain finance provider sends payment to the supplier with fee deducted
- Buyer pays supply chain finance provider at end of credit period
Cash flow management
For suppliers, receiving an early invoice payment helps to close cash gaps and eliminate the need for external funding. With a steadier cash flow, they can focus on maintaining and growing operations. Meanwhile, buyers receive the benefit of extended payment terms without impacting suppliers, freeing up working capital for a longer period of time.
When a buyer provides the option of earlier payments to the supplier, this strengthens the working relationship. Regular, timely payments help build trust and partnership in the long-run, as suppliers are more likely to be loyal and maintain performance if the buyer is reliable.
In SCF arrangements, financing providers take more interest in the credit rating of the buyer when choosing whether to fund early invoices. This can be a positive for suppliers who are smaller and not as established as their buyers, but the reverse is also true if the buyer defaults on a payment or faces financial difficulty.
SCF is often more suited to large rather than small buyers, as they will have a shorter and more limited financial history. The same goes for suppliers — although supply chain finance can help with the power imbalance in relationships between large buyers and small suppliers, there may still be eligibility criteria or minimum requirements that excludes them.
Purchase Order Financing vs. Supply Chain Financing
Although both finance solutions are aimed at supporting supply chain management, each has a distinct application during the finance timeline. A business can use a combination of both to support growth, but through different methods.
PO financing is used for a specific part of the whole supply chain. It covers the immediate cost of a business purchasing inventory from a supplier so a purchase order can be completed. It is only sought by the seller/distributing company, not the supplier. Unlike SCF, this method can be used much earlier in the fulfillment process since it does not require an invoice for approval — only the open purchase order with supporting documentation.
SCF enables a collaborative relationship that helps both buyers and suppliers optimize cash flow and maintain liquidity. It takes place after the goods have been made and delivered and the supplier has invoiced the buyer. While it has a broader function than PO financing, it does have its limits. For example, SCF covers suppliers for purchasing products on the buyer’s behalf, but only to the point that they are credit insured.
Setscale offers fast and flexible PO financing to support businesses of many sizes and meet demand. To find out more about our offering and how to qualify, visit our Solutions page or fill out a request form today.