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.
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