Every small to medium sized distributor has aspirations of business growth. Every distributor aims to increase its sales, grow its market share and secure its long-term future with an aggressive growth strategy, one built on identifying and closing on the biggest opportunities its market has to offer. Unfortunately, it is becoming increasingly difficult for small to medium sized distributors to close large volume orders. Why? Simply put, banks and other financial institutions are still reluctant to extend the working capital small and medium sized distributors need to finance their operations, finance their business and most importantly, finance their inventory. However, there is a solution and it includes taking advantage of an asset-based financing option called “purchase order financing.”
This asset-based financing solution allows distributors to use the value of long-term contracts, confirmed purchase orders and existing backlogs in order to establish a line of credit. Instead of turning business away simply because the capital requirements to fulfill customer orders are too large, distributors can use this asset-based financing option to secure the capital needed to fund the purchase of finished goods from their vendor base. So how does purchase order financing compare to conventional financing?
PO Financing a Business in Today's Economy
Unfortunately, financing is harder and harder to come by in today's economy. It's a reality of managing a business in our global economy, and it's a problem that affects all businesses, regardless of their makeup, their business model, their size or their industry. However, can an argument be made that financing is a bigger concern for small to medium sized distributors, ones who are just getting started? It most certainly can. The reality is that many small distributors are limited in terms of the opportunities they can pursue simply due to a lack of viable financing options. In essence, a distributor that doesn't have access to financing is one whose growth potential is at risk.
Small to medium sized distributors and wholesalers must prepay their suppliers, secure financing through a bank, or rely upon securing a letter of credit. Bank financing is hard to come by as most financial institutions insist on distributors providing financial statements, ones that demonstrate consistent profit and strong cash flow over a minimum of three to four years. Unfortunately, new distributors aren't able to provide that kind of information. A letter of credit is yet another option that is problematic at best. It is incredibly expensive to secure, extremely time-consuming and can often become a drain on a company's internal resources. There is a window of opportunity with respect to using a letter of credit, and it simply isn't conducive to dealing with customers rescheduling deliveries or supplier delivery delays.
Purchase Order Financing
This is ultimately why a number of distributors have come to rely upon purchase order financing. When a distributor defines its assets, it often looks to its inventory, its equipment, its real-estate holdings and finally, any current purchase orders and confirmed backlogs. Purchase order financing allows distributors to use the liquidity of their customers' purchase orders in order to establish a rolling line of credit, one where they can finance their day-to-day operations and one that allows them to prepay their suppliers for finished goods. The distributor secures the financing they need and their customers have the confidence they'll receive an on time shipment. So how does purchase order financing work and what are the conditions for using this asset-based financing option? More about purchase order finance
How Does Purchase Order Financing Work?
Once a distributor secures a large volume order, they can immediately use that order to secure the capital they need to finance their inventory requirements. In essence, a financing company advances the distributor the funds they need to prepay their vendors for product. Once the customer pays the invoice, the distributor covers their credit line and pays a fee for the financing services. It allows distributors to pursue all business opportunities, regardless of their size or capital requirements. In essence, small and medium sized distributors no longer have to question whether they should pursue their market's biggest opportunities.
What are the Benefits of Purchase Order Financing?
Aside from the immediate infusion of capital, there are other benefits to using purchase order financing. First, it allows distributors to secure prepayment discounts from vendors and creditors. In this case, it's not just about lowering the costs of current purchase orders, but also about reducing the costs on all purchase orders. Second, it allows distributors to increase their gross profit on sales by reducing their financing costs of inventory. In essence, small distributors no longer have to purchase inventory in advance. They can reduce the time it takes to finance their inventory by prepaying for finished goods the moment they've secured a purchase order from their own customers. Third, it improves their cash flow, further empowering the distributor to reduce the costs of financing their day-to-day operations.
- Distributors can secure prepayment discounts for all finished goods.
- Increase gross profit on sales by reducing inventory financing costs.
- Improves cash flow and reduces costs to finance operations.
What are the Criteria for Lending?
Contrary to other financing options, purchase order financing companies don't base their decision to advance funds on the credit rating or history of the distributor. They don't ask the distributor to provide financials and they aren't concerned about the company's current cash position. The decision to advance capital is based on the credit rating and payment history of the distributor's end-user customer. This makes purchase order financing an ideal solution for new business ventures, ones who have encountered issues collecting on receivables. In fact, in a number of industries, purchase order financing is the preferred financing solution. It has a well-established history in industries where extended payment terms are the norm.
Can Purchase Order Financing be Combined With other Asset-Based Lending Options?
Yes, distributors that use purchase order financing can combine this solution with receivables factoring. On its own, purchase order financing is repaid to the financing company once the distributor's customer pays their invoice. However, receivables factoring can be combined with purchase order financing in order to reduce costs even further. With receivables factoring, the financing company takes responsibility for collecting on the receivable directly from the distributor's customer. The best part about receivables factoring is that it is similar to a loan with one important exception; it won't appear as a loan on the company's balance sheet.
What Types of Distributors Qualify for Purchase Order Financing?
While purchase order financing is suitable to all businesses, it is especially beneficial to any new distributor just getting their operations off the ground, or any distributor who has had a less than stellar credit rating. It is a financing solution that doesn't require a review of the distributor's financial statements. However, there are some essential rules to follow: First, the distributor's customers must be credit worthy and have a history of paying their receivables on time. They can't be enterprises that consistently exceed their credit limit and terms. Second, purchase order financing is ideally suited to product lines with healthy gross profit margins on sales. After all, there is a cost to this financing option and it often isn't conducive to distributors whose products have razor thin gross profit margins. Third, distributors must properly manage their credit lines and cover the transaction fees charged by the financing company.
Do Banks Offer Purchase Order Financing?
Most banks don't offer purchase order financing and only a select few offer receivables factoring. Banks tend to stick with conventional lending and financing. They measure risk by how well an established enterprise performs over time. If that enterprise has demonstrated a history of performance, has solid financials and a strong cash position, then a bank is likely to advance the company funds. These three criteria are incredibly difficult to meet for small and medium sized distributors, especially ones who are just trying to make inroads within their market.
Purchase Order Financing Funds Future Growth
At the end of the day, purchase order financing works because it provides distributors with an alternative financing option, one that allows them to finance their future growth. Distributors no longer need to be at the mercy of banks and credit unions. They no longer have to worry about their credit history or credit rating. They no longer have to turn business away simply because they lack the ability to finance their inventory. Finally, they no longer have to worry about their ability to remain competitive with larger, more established market leaders.
Financing is a concern shared by a number of small to medium sized distributors and it's one that can easily put a halt to any enterprise's growth strategy. In fact, lack of financing could be the reason a company loses out on competitive bids. It's important that distributors investigate this alternative financing solution. Purchase order financing is an asset-based lending option that will reduce a company's costs of capital, lower its financing on inventory, improve its cash position, and most importantly, allow it to go toe-to-toe with its market's biggest competitors.
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