Positive cash flow is the lifeblood of your business. In fact, cash flow issues rank among the top reasons for small businesses failing. Running into some cash flow issues does not necessarily mean that your business will fail, but it is a red flag if it happens too often and if your business does not have a plan in place to compensate if things hit a snag.
If you find yourself in a position where you’re not able to complete customer orders and requests due to a lack of cash on hand, a potential solution is finding a party willing to do purchase order financing.
Purchase order financing is exactly what it sounds like: a vendor that gives you money for the sole purpose of completing orders.
In most cases, it helps to have an existing relationship with the purchase order financer, though each individual instance is usually approved on a per case basis. You would receive an order and confirm that you are not able to make a purchase from a vendor necessary to complete the order. You’d usually get a quote from the vendor to confirm.
Once you know you can’t pay, you would contact your purchase order financer and seek approval for the order. If approved, they would then directly pay the supplier for what you need - sometimes up to 100% of the cost, though in many cases, they might require you to pay for some small portion.
You get the supplies and satisfy the customer’s order. You send the customer an invoice, and they pay the purchase order financer. They will then forward you the money you earned, minus their fees and interest.
Purchase order financing can be an excellent option as a backup plan for cash flow problems. It’s typically easy to qualify for them, granted you can prove that you will deliver on the service once you receive the supplies. Very often, the loan is more dependent on the credit and payment history of the customer, not you.
This makes it a particularly good option for a start-up with not much history, or a small business that has hit a few snags.
The drawbacks are directly related to the positives. Given that there are few prequalifications, the fees and interest can be very high. It’s not a good option if you have pre-existing loan agreements or credit on hand that you can use to float you through a down period if you know you’re expecting an upswing.
And it’s not a good option if you don’t believe the customer will be able to pay quickly, or the work will take a long time to complete. The interest and high fees will compound very fast.
There’s also the idea to consider that your customer will know that you used some sort of financing to get the deal done. While that might not make a difference to you as far as completing the order, it could leave the impression with your customer that you aren’t able to stand on your own.
Purchase order financing is a great short-term option to bail you out of a financial bind and keep you finishing orders and earning money even if you don’t have enough cash on hand to. Weighing the drawbacks, it could be a great option to help float your business and another weapon to keep in your arsenal.