Your ideal customer just inquired about placing a large order from your startup. It sounds like a dream come true, right? Well, at least it did before you checked your inventory and realized you didn’t have the goods on hand to deliver and don’t have the cash to purchase what you need from your supplier.
But don’t throw in the towel just yet. You have options available that can help you fulfill this order and potentially gain a lifelong customer.
For small and scaling companies that don’t have cash on hand to fulfill large orders, purchase order financing can be a viable solution.
What is purchase order financing?
Purchase order financing allows businesses to finance goods necessary for production from their suppliers before receiving payment from a customer. The advanced funds can only be used to purchase goods supporting the customer’s order.
Purchase orders are legal documents issued by buyers communicating the intent to purchase goods from a company. If the company selling the goods does not have the inventory to fulfill the order or purchase materials from their supplier, the purchase order can be used to apply for advance funding paid to the supplier to support the fulfillment of the order.
Purchase Order Financing for Startups
Wondering who purchase order financing is for? Startup companies that do not yet have the capital to fulfill large orders can benefit from purchase order financing. For many startups, they do not yet have the track record of success to qualify for other funding options and can be negatively impacted by turning away customer orders.
Purchase order financing can make growing startups more competitive by enabling them to take on more orders, fueling sales growth and future cash flow.
Now that we know what purchase order financing is, let’s review how purchase order financing works.
How Does Purchase Order Financing Work? [Template]
There are typically four parties involved in purchase order financing transactions. They are:
Seller/borrower — The company that needs financing to fulfill the customer’s order.
Lender — This company finances the transaction. They review the purchase order and borrower’s qualifications to disperse funds directly to the supplier to fulfill the order at hand.
Supplier — This party provides the goods or materials needed to fulfill the order. They receive initial funds directly from the lender.
Customer — The customer provided the initial purchase order requesting goods from the borrower’s company. They receive the final product delivered by financing. Their payment typically goes directly to the lender.
Understanding who is involved in a purchase order financing deal, let’s walk through the steps it takes to complete this type of order.
1. The customer issues a purchase order.
To begin the process, a customer sends a purchase order to a seller with the intention of making a purchase. The purchase order specifies the product, the number of units, and the date they would like to receive the order by.
For example, if an office manager decides to upgrade the furniture in their office building and wants to purchase 100 new office chairs, they can start by drafting a purchase order and sending it to the furniture company they would like to order from. The purchase order should indicate the specific chair they would like to order, the number of chairs (in this case, 100), the delivery address, and the date they would like to receive the chairs.
2. The seller requests a quote from the supplier.
Once the seller receives the purchase order, they can share the purchase order information with the supplier. The supplier determines if they have the inventory to fulfill the order, and sends the seller a quote outlining how much it will cost to fulfill the order.
Once the seller has this information, they can determine if they have the cash on hand to make the purchase from the supplier upfront, or they can decide to pursue purchase order financing to pay the supplier.
Continuing the example above, when the office furniture company goes to their supplier to price the order of 100 chairs, they realized they did not have access to enough funds to purchase the chairs from the supplier. They decided to pursue purchase order financing to provide the chairs to the customer.
3. The seller applies for purchase order financing from a lender.
Once the seller decides to pursue purchase order financing, they must apply for the funds needed from a financing company. The customer’s initial purchase order and the quote from the supplier must be provided to be considered for funding.
In the case of the office furniture, the furniture company applies for funds from a financing company. After reviewing the initial purchase order, the supplier quote, the lender has approved the seller’s application and agrees to finance this effort.
4. The lender pays the supplier to fulfill the order.
After the seller has been approved, the lender provides the necessary funds to the supplier directly. This amount should cover the cost of manufacturing and delivering the goods requested in the purchase order.
5. The supplier fulfills the order.
Once the supplier receives the funds from the lender, they provide the products outlined by the original purchase order and deliver the goods directly to the customer. The seller is typically not involved in this step.
For example, when the furniture supplier makes and ships the 100 chairs, they send the order directly to the office manager who provided the initial purchase order. The office furniture company does not serve as a middleman during this step of the process.
6. The seller sends an invoice to the customer.
After the supplier delivers the order, the seller sends an invoice to the customer requesting payment. The payment terms outlined in the invoice should adhere to the terms outlined by the lender when they provided the initial funding.
7. The customer pays the invoice.
When the customer pays the invoice, their funds go directly to the financing lender.
Again, during this step of the process, the furniture company is not serving as a middleman. The office manager will pay the financing lender directly.
8. The lender takes applicable fees and disperses the remaining funds to the seller.
Once the lender receives the funds from the customer, they take any applicable fees as outlined in their original lending agreement, and give the remaining funds to the seller
Here’s a purchase order template that can be used for this process:
Purchase order financing can be a helpful solution for startup companies who are experiencing rapid growth but are still waiting for cash flow. Looking for more advice to help you grow your startup? Check out this post to learn how startups can achieve massive growth.
Originally published Nov 22, 2019 7:30:00 AM, updated June 15 2021