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Preparing an Application for Purchase Order Financing

Posted on January 25, 2018 in Purchase Order Finance

Purchase Order Financing has been around for a long time. This usually involves several parties in the transaction and there are many variables in the underwriting process to consider. The mechanics of funding the transaction may vary by industry sector and your business model.

If your business is considering a purchase order finance company as an alternative lending source, you should be prepared and research on how the finance company will review your business for approval.

Based on the findings of your research, it is suggested to implement changes to address the cPurchase Order Finance Application processoncerns a lender may have in approving your request. Positive changes can make your transaction more attractive for a larger scope of lenders and can be the difference between an approval or not.
This article contains many questions to research for your business, and see if your business will be a fit for a PO finance company.

What is Purchase Order Financing?

PO Financing involves a specialized lender that provides transactional financing to a vendor/business (the Applicant) to help process an order requested by a credible account debtor (Customer being sold to). The financing arrangement is not a long-term loan that you make payments on but rather more of a single investment into the transaction that will convert to an invoice within 30 to 120 days when the product is delivered. The fees calculated in po finance is based on many variables, and fees can vary between 1%  to 15% of the transaction value.
Keep in mind, the mechanics of the po finance is to fund the transaction and get it to a deliverable state whereas the the product is accepted by the account debtor and the business can generate an invoice. Once it becomes a receivable then the po finance company is paid off by a factoring company or the account debtor. The majority of po finance companies will not factor the invoice, so arrangements should be made on how the po finance component will be paid off.

What are the typical parameters considered in PO Financing?

Many things will be considered during the review process and it all comes down to risk, type of product/services rendered, number of days it will take to get it delivered, transaction history between vendor and the account debtor, and one of the most important of all “Gross Margin”.

So lets break down the typical parameters:

Risk – The Longer your business has been around the less risk the lender may have. However, that is only one of many components reviewed.

  • How long has the business been selling the same product? New product rollouts are higher risk because there is no sales history.
  • Is this a first-time sale to customers, or is it a recurring item that is regularly ordered from customers.
  • Is this an inventory item that can be auctioned out easily or is it a very specific item with very limited buyers? Is it a private labeled item? Does it involve copyright infringements if sold at the auction?
  • What is the return policy, historical dilution rate? Shelf life?
  • Is this a finished product ready to ship once its paid to suppliers, or does it involve manufacturing it? How many suppliers will be involved?

How is the Purchase Order structured and what is the Account Debtor Credit Strength:

  • Is the Account Debtor Credit Worthy, and for how much? Is it credit insured?
  • Will the Account Debtor allow/acknowledge a notice of assignment for the receivable to the lender? Is the Account Debtor pledged by the business under an invoice factoring arrangement? Will the factoring company accept an inter-creditor agreement with the po finance company?
  • What are the credit terms? Net 30, 60, 90, 120?
  • Is this a consignment deal or billed as delivered?
  • What are the terms of the Purchase Order? Expiation dates, and what are the consequences if not delivered on time?
  • What are all the other contingent clauses attached to the sale of these products

Suppliers and the Vendor/Applicant

  • How long has the business worked with its suppliers? Have they been consistent and are they financially stable
  • Are there credit terms already established by the business with its suppliers? If yes, is the business current on its payables obligations to these suppliers?
  • Is there any liens from any banks, other lenders or suppliers encumbering the inventory and accounts proceeds of the business?

What items will a PO Finance Lender not consider funding in the transaction?

Depending on the transaction, most lenders will not fund for inventory items not related to the purchase order being financed. In addition, other cost usually not considered is freight cost, customs/broker fees and labor cost.

How much does the vendor have to invest into the transaction?

Some lenders will provide up to 90% of the cost while some others require more from the vendor. Lenders feel that if the vendor has some out of pocket money in on the deal, they will see through that the order gets completed and delivered as requested on the terms of the purchase order.

A recipe for disaster in PO finance!

A perfect storm in purchase order funding involves a vendor that’s new in business selling a new item in the market with no sales history, dealing with suppliers that want cash before shipping to an account debtor that’s ordering for the first time wanting a return guarantee if it doesn’t sell. The reality is these deals never get approved.

As a rule of thumb consider the following as a minimum for approvals:

  • Minimum of 6 months sales history for each customer with the same products (not new items) that are under a factoring arrangement.
  • At least 1 year dealing with the suppliers and the business has established some credit terms with suppliers.
  • In the event of a return or a canceled purchase order, Items are resalable at an auction without contingencies.
  • Gross Margin is at least 25% to 30%

1st Commercial Credit can accommodate both the invoice factoring and purchase order component including labor and freight cost involved. We use innovative ideas in funding transactions and each client is unique and we come up with a customized solution for each situation.