Many business opportunities come with an associated challenge. For most entrepreneurial companies, the biggest challenge is financing the business opportunities created by their sales efforts. What are your options if you have a sales opportunity that is clearly too large for your normal scale of operations? Will your bank provide you with the necessary financing? Is your company a new company or too new to meet the bank’s requirements? Can you take advantage of a commercial real estate loan or home equity loan in plenty of time to complete the transaction? Do you reject the request? Fortunately, there is an alternative way to meet this challenge: You can use Purchase Order Financing and Letter of Credit Financing to deliver the product and close the sale.
What is purchase order financing?
Purchase order financing is a specialized method of providing structured working capital and loans secured by accounts receivable, inventory, machinery, equipment, and/or real estate. This type of financing is great for start-ups, refinancing existing loans, growth financing, mergers and acquisitions, management buyouts, and management buyouts.
Purchase order financing is based on bona fide purchase orders from reputable and creditworthy companies or government entities. Verification of the validity of purchase orders is required. Financing is not based on the financial strength of your company. It is based on the creditworthiness of your customers, the strength of the commercial finance company financing the transaction, and, in most cases, a letter of credit.
What is a letter of credit?
A letter of credit is a letter from a bank that guarantees that a buyer’s payment to a seller will be received on time and in the correct amount. If the buyer cannot pay for the purchase, the bank is obliged to cover the full amount of the purchase. In a purchase order financing transaction, the bank relies on the creditworthiness of the commercial finance company to issue the letter of credit. The letter of credit “supports” the financing of the purchase order to the supplier or manufacturer.
Is purchase order financing appropriate for your sales program?
The perfect paradigm is a distributor buying products from a supplier and shipping them directly to the buyer. Finished goods importers, finished goods exporters, contract manufacturers, wholesalers, and distributors can effectively use purchase order financing to grow their businesses.
Is purchase order financing adequate to grow your sales orders?
Purchase order financing requires you to have management experience, a proven track record in your particular business. You must have good purchase orders from reputable firms that can be verified. And you must have a payment plan; often this comes from a commercial finance company in the form of accounts receivable or asset-based financing.
You must have a gross margin of at least 25% to benefit from purchase order financing. Sellers of low-margin commodities or services, such as lumber or grain, will not qualify.
The final decision for purchase order financing:
It can take two or more years to build a profitable business. Banks generally base their loan limits on a company’s performance over the past two to three years. Purchase order financing, combined with letters of credit and/or accounts receivable or asset-based financing can provide you with enough funds to cover your operating costs, financing costs and still make significant profits. If you qualify for purchase order financing, you can grow your business by taking advantage of large purchase orders and eventually qualify for bank financing.
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