As a business owner, you’re constantly faced with decisions that impact your company’s success and future growth. Tight cash flow can restrict operations and limit opportunities. When working capital runs low, you have financing options like purchase order (P.O.) financing and invoice factoring to leverage your unpaid invoices.
While ‘purchase order financing vs factoring’ is a common debate, savvy business owners recognize that purchase order financing often serves as the vital first step, opening the door to the benefits of factoring. Read on as we detail the complementary roles of purchase order financing and invoice factoring in business finance.
Understanding the Roles of P.O. Financing and Factoring in Business Growth
What is the Role of Purchase Order Financing?
Purchase order financing provides funding based on open purchase orders you have received from customers. With P.O. financing, a lender offers capital so you can fulfill customer orders by purchasing inventory and materials from your suppliers.
Since lenders provide funds against open purchase orders rather than completed work, it’s ideal for paying supplier invoices when you would otherwise have to wait 30, 60 or 90 days for customer payment. This flexibility empowers you to accept new orders and continue growing your manufacturing business.
Specifically, P.O. financing helps:
You receive a large purchase order but lack the cash on hand to fulfill it.
You need to pay suppliers for raw materials and inventory before production.
Your suppliers require upfront payment before they will start work.
You want to finance seasonal inventory and supplies.
You have outstanding purchase orders from creditworthy businesses.
P.O. financing acts as a catalyst, helping your business maintain momentum by ensuring you can fulfill orders even when waiting for customer payments. It’s the first step in a financial process that sustains and grows your business.
What is the Role of Invoice Factoring?
Invoice factoring comes into play once you’ve fulfilled orders using P.O. financing. Factoring provides liquidity based on completed and invoiced work. It helps accelerate cash flow by advancing funds against unpaid invoices for finished goods or services.
Factoring helps when:
You have outstanding invoices from other businesses or government entities.
You want to get paid faster instead of waiting up to 90 days.
You need flexible working capital not tied to a specific purchase order.
You want to avoid taking on business debt.
You have gaps in cash flow due to uneven revenue cycles.
This transition from P.O. financing to factoring illustrates a complete financial cycle. P.O. financing addresses the upfront needs of fulfilling orders while factoring ensures swift liquidity post-completion. Understanding this sequential process allows you to better align these financial tools with your business’s operational needs and growth trajectory.
Qualification Requirements for Purchase Order Financing and Invoice Factoring
When applying for financing, invoice factoring and P.O. financing have other distinct differences in what lenders look for when determining approval. Here are the qualifications and criteria to be aware of for each:
Purchase Order Financing
Mitigating lender risk before work is done
Customer’s ability to pay for completed work
Purchase order from a creditworthy business
20%+ profit margin on order
History of fulfilling similar orders– $100K+ minimum order size
Tangible finished goods– Creditworthy suppliers
Invoices from businesses or government
Customers have strong credit
No other claims on receivables
No restrictions on the use of funds
Importance of Your Business Credit
Considered but not heavily weighted
Very little importance
Importance of Customer Finances
High importance – order and suppliers thoroughly vetted
High importance – customer credit is key
How Purchase Order Financing Works
P.O. financing provides capital to manufacturers, wholesalers, distributors and other businesses to fulfill customer orders. Here are the typical steps involved:
Your business receives a large purchase order from a new customer, but you lack the available cash or credit to pay for the raw materials and inventory needed to fulfill it.
You apply for purchase order financing with the key details of the order, such as the purchase amount, customer information, and supplier costs. The P.O. financier reviews the application and approves your financing request.
After approving the P.O. financing, the lender provides the agreed-upon amount of funding so you can pay your suppliers to procure the required raw materials and start production.
With financing secured, you place orders with your suppliers. They manufacture or deliver the finished goods and products directly to your customer per the purchase order.
Once your customer receives the completed order, you send them an invoice for payment, just as you usually would.
On the due date, your customer pays the invoice directly to the P.O. financing company rather than your business.
After the customer pays in full, the P.O. financier deducts their fees and interest charges from the amount received. They then remit the remaining balance to your business.
This process injects capital into your production cycle and allows you to accept larger purchase orders from new customers. While P.O. financing sets the stage by focusing on the potential of future orders, factoring takes over once those orders are fulfilled and invoiced, providing a seamless financial journey.
How Purchase Order Financing Helps Your Business
Access Capital to Take on More Orders: P.O. financing provides the funds you need to fulfill purchase orders, even if you lack the cash to pay suppliers upfront. This flexibility allows you to accept more orders and grow your business.
Pay Suppliers Without Delay: Rather than make suppliers wait weeks or months for payment, P.O. financing gives you the capital to pay them right away. Paying earlier helps strengthen your supplier relationships.
Easy to Qualify Based on Purchase Orders: Lenders focus on the purchase order details rather than your business’s creditworthiness when approving financing. As a result, it is easier to get approved quickly compared to traditional business loans.
How Invoice Factoring Works
Invoice factoring provides cash flow financing for manufacturers, staffing firms, contractors and other B2B businesses by leveraging their accounts receivable. Here’s how the invoice factoring process typically works:
You complete a project or deliver goods and services to your business customer as usual. You invoice the customer per your existing billing terms.
Rather than waiting 30, 60 or 90 days for the customer to pay, you can submit copies of the unpaid invoices to an invoice factoring company, which assigns your right to payment to the factor.
After reviewing the invoices, the factoring company will advance you a large portion of the invoice amounts, usually 70-90%. Getting this capital within a few business days gives you quick access to the operating funds you need.
On the due date, your customer pays the full invoice amount directly to the factoring company as the new receivable owner.
Once payment is received, the factoring company deducts its discount fee or interest charge. Then, it sends the remaining balance from the invoice to your business.
Factoring accelerates cash flow by enabling you to get paid early on work completed. For manufacturers with uneven revenue cycles, it provides flexibility to meet payroll and cover overhead until additional payments arrive.
How Invoice Factoring Helps Your Business
Rapid Funding: With factoring, you can receive an advance on invoices in as little as 24 hours, enabling quick access to cash flow.
No Debt: Factoring does not involve loans or financing, so you avoid taking on expensive debt that must be repaid over time. The factoring company handles collecting directly from your customers.
Flexible Use of Funds: You can use the funds for any business need, such as payroll, equipment or growth opportunities.
Purchase Order Financing vs. Factoring: Which is Best for Me?
As you can see, purchase order financing and invoice factoring are not just individual options to accelerate cash flow and access capital; they are sequential steps in a comprehensive financial strategy. Rather than choosing one over the other, consider how both can play a vital role at different stages of your business cycle. Understanding how these two methods work together can transform how your business handles its finances.
At ei Funding, we understand your business’s unique financial challenges and opportunities. With tailored guidance, you’ll be empowered to make strategic financing decisions that provide growth capital while retaining ownership of your company. Our experts take the time to understand your business goals, cash cycles and growth plans.
Want to learn more? Contact ei Funding today to speak with a financing expert. We’re here to demystify invoice financing so you can select the right solution to take your business to the next level. The growth you’ve dreamed of starts today!
Ernane Iung is a seasoned C-suite executive with a 28-year dynamic career across four continents, including two decades in São Paulo, Brazil, where he held key roles with renowned multinationals such as GE, Whirlpool, Philips and Oster.