Your worst business nightmare just occurred. You got the order/contract! Now what?!
Purchase order financing is a great tool for firms that have unusual purchase order and contract sales financing needs but are potentially unable to access traditional financing via banks or their own capital resources within their firm. So how does trade finance P O financing work, does your firm qualify, the costs, and how does it work? Great questions, now let’s explore some answers!
Typically Canadian firms looking for this type of financing are distributors, manufacturers, or perhaps wholesalers. A variety of industries in Canada have access to this type of financing, but those certainly tend to be the typical firms needing assistance.
Your need for purchase order financing arises out of what we call the classic working capital gap. What do we mean by that? It’s a case of your suppliers requiring payment either up front or within 30 days, with your firm unable to generate those funds for payment and therefore unable to fill large purchase orders and contracts in your favor. So your supplier is asking you for payment in advance or 30 days, and you won’t receive payment for at least 60-90 days, perhaps more depending on your build cycle, etc.
Naturally, you don’t want to turn down orders or lose your competitive market position.
The obvious solution for low-cost large amounts of funds are Canadian chartered banks. Still, our observation is that many firms simply can’t satisfy the bank’s requirements for this type of financing to occur. If your firm is growing, profitable, has a clean balance sheet and strong historical cash flows and history, you, of course, have a solid chance of meeting bank requirements; however, that typically is not the case, certainly in the number of clients we talk to who are looking for alternatives to their growth challenge!
When you access p o financing, you can have the comfort that your suppliers will be paid, and at the same time, you generally have access to all the funds you need. Typical purchase order financing applications take anywhere from 2-4 weeks to complete and involve basic financial due diligence on your firm’s ability to fulfill the order, who your customer is (they must be creditworthy), and your proper supplier sources must be identified and vetted. It’s as simple as that.
So what are the basic prerequisites for a solid P.O. Financing deal? Naturally, your company must have a contract or order that is not cancelable by your client. The P O finance firm arranges to pay your suppliers directly, alleviating all your cash flow and working capital concerns. The transaction is completed when you ship the goods, and your receivables are generated on the sale. At this time, the purchase order finance firm expects to be paid, which is traditionally handled by your firms monetizing of its receivable via a bank or factoring facility. Factoring facilities are great partners to the P O financing strategy because the use guarantees payment to your P O firm.
Let’s cover a couple of tips and secrets around the cost of purchase order financing – It is generally in the 2-3% per month range in Canada. That means you have to have solid gross profit margins to be able to sustain the finance charges. But let’s be honest, let’s say your firm has been doing 750k of revenue for the last couple of years, and you finally get a large order from a major customer for 1 Million dollars. Wouldn’t you give up 2-3 % of your profit margin to make one sale which is the equivalent of your entire year’s business? We think you should positively consider that! Clearly, the higher cost of this type of financing covers the complexity and risk that the P O finance firm takes in paying for goods, waiting to get paid, and having the belief that your firm will fulfill the contract order.
Our observation with certain clients that your successful completion of a purchase order finance deal typically significantly enhances your relationship with your major suppliers and, of course, customers; that’s a secret benefit that is intangible but invaluable at the same time.
Is P O financing for everyone. Maybe not. Could it possibly be the solution to major working capital needs if your business is growing and can’t be financed traditionally – we certainly think so? Speak to a trusted, credible, and experienced purchase order finance expert to explore your options.