Purchase order (PO) financing is short-term funding that lets a business fill a confirmed customer order when it cannot afford to pay its supplier up front. The financier pays the supplier directly, and is repaid when the customer pays for the delivered goods.
How it works in factoring
PO financing and factoring often work in sequence:
- A business receives a purchase order from a creditworthy customer.
- The PO financier evaluates the customer, the supplier and the order's margin.
- The financier pays the supplier, often through a letter of credit or direct payment.
- The supplier produces and ships the goods to the customer.
- The business invoices the customer, and the invoice is often factored to repay the PO financier.
- When the customer pays, remaining profit goes to the business after fees.
Illustrative example: A reseller wins a $200,000 order for goods that cost $140,000 from a manufacturer. A PO financier pays the manufacturer. After delivery, the $200,000 invoice is factored, the PO financier is repaid with its fee, and the reseller keeps the margin, less financing costs.
PO financing generally suits businesses that resell finished goods or use contract manufacturers. It is less common for services or for businesses that do significant manufacturing themselves.
What to check
- The margin on the order; PO financing usually requires enough gross margin to cover fees
- Supplier reliability, since delivery failure puts the whole transaction at risk
- How fees accrue if production is delayed
- Who handles the factoring step and how the two financiers coordinate
PO financing can let a small business take on an order much larger than it could otherwise fund.