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Virtually all businesses need injections of working capital from time to time. However, if you are a small business owner or a startup, you may not qualify for traditional financing like large corporations and established businesses can obtain. Enter PO financing and invoice factoring.

Purchase Order Financing vs. Factoring: How They Work

These popular funding options can provide you with working capital to cover expenses, but they work differently and serve different niches sometimes. Below, we’ll give you a full breakdown of the main differences and how each one works and what to expect, so it’s easier to identify which is the best solution for the current needs of your business.

How Does Purchase Order Financing Work?

Sometimes shortened to PO financing, purchase order financing provides funding for finished goods that you plan to sell to another business. The process generally goes something like this:

  1. Your customer places an order with you.
  2. You realize you need to purchase finished goods or inventory to fulfill the order.
  3. You get an estimate for the goods from your supplier and confirm you don’t have the cash to cover your expense.
  4. You apply for purchase order financing and get approved.
  5. Your purchase order financing company pays your supplier.
  6. The supplier sends the finished goods directly to your customer.
  7. You invoice your customer.
  8. Your customer pays the purchase order financing company.
  9. The financing company deducts their fees and the purchase cost, then sends you any remaining cash balance.

What Types of Companies Use PO Funding?

Virtually any business that purchases and sells finished goods to other businesses or government agencies can use PO financing.

  • Resellers
  • Wholesalers
  • Distributors
  • Outsourced Manufacturers
  • Importers and Exporters of Finished Goods

Qualifications for Purchase Order Financing

For PO financing to work for your business, a few things must come into alignment.

Finished Goods: Generally speaking, the transaction must involve finished and unmodified goods. For example, you might purchase dresses and sell them to a retailer. However, you can’t purchase materials to make dresses for a retailer.

Customer Credit: Because the customer will ultimately be the one making invoice payments, the PO financing company will want to examine their creditworthiness before approving your funding.

Supplier Reputation: PO financing companies will only pay vendors if they appear to be capable of fulfilling the order and are financially strong. If the supplier requires prepayment, has a history of failing to deliver, or sets off other alarm bells, you aren’t likely to qualify.

Terms of Sale: Most lenders will only finance deals starting at $100,000 with a 20-30 percent profit margin. They also prefer that you have worked with both parties before and have completed a transaction for the same product at least once before. Lastly, your agreement will usually have to stipulate that the order cannot be canceled.

Your Business Standings: Naturally, the lender will want to ensure your business is fiscally strong too. Although your credit won’t matter as much as the customer’s, they’ll still want to review your financial statements and ensure no tax or legal problems on your end could prevent them from collecting. Lastly, they’ll want you to pay for a portion of the order up front and prefer to work with business owners that have contributed financially to their companies.

When to Choose Purchase Order Funding

Purchase order financing more or less removes you as the middleman from a transaction but still provides you with a cut of the revenue from the transaction. You’ll usually pay a fee of two to six percent per month while the invoice is outstanding. That may not be a huge deal if the customer pays upon receipt of the goods, but it adds up if the customer takes 60 or 90 days. Even still, it’s a solid option if you’re a small-business owner with the opportunity to fulfill large orders from big companies and wouldn’t be able to accept them without some kind of funding.

Alternatives to Purchase Order Financing

How Does Invoice Factoring Work?

Sometimes referred to as accounts receivable factoring or invoice financing, factoring accelerates your cash flow by providing you instant payment for work you’ve already completed or goods you’ve delivered. It eliminates the customary 30, 60, and 90-day payment waits most businesses wrestle with. A typical process goes something like this:

  1. You connect with a factoring company to confirm you qualify for factoring.
  2. You complete work like you normally do.
  3. You invoice your client.
  4. You submit your invoice to your factoring company.
  5. The factoring company pays you most of the invoice’s value. In some cases, you can receive payment on the day you submit.
  6. Your client pays the factoring company.
  7. The factoring company deducts their fees, then sends you any remaining cash.

What Types of Companies Use Invoice Factoring?

Qualifications for Invoice Factoring

Invoice factoring has few requirements. Qualifying mostly comes down to two things.

B2B Invoices: As long as your customers are other businesses, you bill them after you’ve delivered goods or services, and no other entity has a claim to your receivables, invoice factoring can work.

Customer Credit: Like PO financing, the creditworthiness of the customers matters as they’ll be the ones handling repayment by paying their invoices.

Note: Things like your business credit and how you plan to spend the money aren’t major concerns with factoring.

When to Choose Invoice Factoring

Invoice factoring is sometimes described as selling your unpaid invoices to a third party at a discount. Your fees will vary depending on how much you factor, the value of the invoices, and other details, but rates are as low as 0.25 percent when you work with Viva.

Naturally, invoice factoring is the better solution if you won’t qualify for PO financing because you need cash for something other than finished goods such as payroll, your supplier doesn’t have good credit, or you don’t need six figures’ worth of goods. It’s also generally the less expensive of the two options.

Alternatives to Invoice Factoring

How PO Financing & Invoice Factoring Can Work Together

If you’ve found a great deal on PO financing but are still short on cash between cycles or want to accelerate payment on certain invoices, you can alternate between PO financing and invoice factoring as needed depending on your specific concern at the time.

Request a Free Factoring Quote

If it sounds like invoice factoring could be the ideal solution to your business funding needs, start with a free quote from Viva.

Sarah Williams

Sarah Williams, Vice President of Sales at Viva Capital, is responsible for strategy and direction of sales and marketing departments. Over 15 years of experience in factoring and specialty finance. Now a veteran, she has served in the United States Army for eight years.