What is Purchase Order Financing?
March 27, 2018 • 3 min read
Purchase Order Financing
In this article, we discuss Purchase Order Financing, a financing arrangement that helps businesses that need cash fulfill product orders.
What is Purchase Order Financing?
Where Your Investment Goes in a POF Offering
When investing in a Purchase Order Factoring offering, your money goes directly to an originator, (in this case a Financing Company) whose mission is to provide its clients with the essential working capital they need to grow and expand. The originator seeks to fund undercapitalized, but highly competent businesses that are in the process of expanding their sales volume to credit worthy customers.
Why We Like Purchase Order Financing Offerings
At YieldStreet, we like Purchase Order Financing offerings because they are asset-backed, short-duration and generally non-correlated to the stock market. For a similar process, more check out our article on Invoice Factoring and view YieldStreet University for more overall resources. Please also visit our offerings page for information on all upcoming investment opportunities.
Purchase Order Financing (POF) is the practice of using a business’s customer purchase orders as collateral to obtain cash advances from a third-party finance company.Let’s Break it Down As businesses grow or encounter fluctuations in demand, they may require additional funds to fulfill orders from customers. Consistent and predictable cash flows are critical for both growing and cyclical businesses. However, without the necessary working capital on their balance sheets to fulfill customer orders, these businesses may miss out on opportunities to scale or service high value customers. Traditional bank financing can sometimes fulfil this need through working capital or short-term business loans; however, banks are often constrained in their ability to fulfil this type of financing due to regulatory restrictions or inflexible credit structures. As a result, high potential companies may find themselves missing out on growth opportunities or with diminished performance during periods when sales outpace incoming revenues. Banks vs. Purchase Order Financing Companies Raising cash by increasing debt may be difficult for companies that are already levered or, like most startups, lack an extensive credit history. In addition, bank approval times for loans can have long time horizons or onerous reporting requirements. POF provides another avenue for companies to raise capital without having to add debt to their balance sheet or waiting on protracted bank approval periods. Businesses can receive funds within a few days through purchase order financing, as compared to possibly a few months with a bank. Here’s a Hypothetical Example of How it Works: Turbo Bros. is a business that manufactures specialized steel products like car engines and wind turbines. Turbo Bros. is a relatively small business but has a stellar track record of delivering great products on time to its customers. One day they receive a massive order for 10,000 new car engines from one of the nation’s biggest car companies, Rev Motors. Turbo Bros. determines they can pull off the order and plans to charge Rev Motors $15 million for the engines. However, Turbo Bros. doesn’t have sufficient cash on their balance sheet to purchase the massive amount ($10 million worth) of raw steel required for the order from their supplier, RawMat.
- Rather than turning the order down, Turbo Bros. reaches out to a Financing Company, Finer Factoring, to help them finance the $10 million raw steel order.
- After doing due diligence on each of the businesses involved, Finer Factoring approves the request from Turbo Bros. and forwards the funds to the supplier, RawMat, directly.
- RawMat ships over the steel to Turbo Bros. to begin making the engines for Rev Motors’ order.
- Turbo Bros. then delivers the completed engines to Rev Motors.
- When it’s time for Rev Motors to pay the $15 million for the engines, Rev Motors sends the money directly to Finer Factoring.
- Finally, Finer Factoring sends the $15 million payment (taking out fees and commission for their service) to Turbo Bros.
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