In North America, a Purchase Order (P.O.) is a legal agreement signed by a buyer requesting a seller to provide goods or services. Purchase Orders normally list the amount of goods or services required and the terms and conditions of delivery and payment.
Major domestic buyers will normally issue a P.O. requiring extended payment terms such as Net 30 to 60 days. Overseas suppliers will usually ask for COD or sight draft Letter of Credit terms. For a middleman importer, this difference in terms of purchase and of sale can be a problem.
Purchase Order Financing can be a solution to this cash flow dilemma. Purchase Order Financing is a short-term funding technique used to finance the purchase or manufacture of goods that have been presold to a creditworthy customer. Lenders that offer this specialized form of financing can assist in the purchase of product inventory by using the inventory and confirmed purchase orders as collateral.
Importers, Exporters, Distributors, Manufacturers are all candidates for Purchase Order Financing. Funds may be used for issuing Letters of Credit, cash payment to suppliers for finished goods, raw materials or direct labor. Purchase Order Funding is a risky form of financing and therefore costs more than traditional financing. It requires extensive due diligence, and lenders are highly selective. If you can meet the prerequisites there are several excellent P.O. lenders who work with TEFO to offer you a financial solution.
California Accents is a San Francisco-based importer and distributor of kitchen and bathroom tile. The company has worked for more than a year to land a big order from Home Depot - the largest home improvement retailer in the U.S. A Purchase Order (P.O.) in the amount of $426,000 arrives. The P.O. requires that California Accents deliver product in 120 days and must extend 60 days open account terms.
California Accents quickly contacts their tile supplier in Sri Lanka. The factory manager says that they can ship the tile in 45 days for a cost of $312,000. However, they must have a Sight Draft Letter of Credit (L/C) in the amount of $312,000 to help them get the financing they need to fulfill the order. California Accents doesn't have $312,000 in operating capital and their bank regrets to inform that they can't help. It appears the company has already maxxed out their credit line.
California Accents calls a Factoring company. The factor likes the buyer. They will finance the 60 days Accounts Receivable that will be generated from the transaction. But the Factor advises that they only finance Accounts Receivable. That means they won't provide any funds until the product has been shipped and accepted by the buyer. California Accents still needs the cash, credit or a strong guarantee to get their bank to open a Letter of Credit for the supplier. The Letter of Credit will get the supplier to manufacture and ship the tile so California Accents can deliver product to Home Depot. At that point, California Accents can convert the Home Depot shipment to a 60-day Accounts Receivable.
California Accents calls TEFO. We package the transaction with an experienced P.O. Finance company. After intense due diligence the P.O. Finance company agrees to have their bank open a Letter of Credit for $312,000, on behalf of California Accents. The Sri Lanka manufacturer, as L/C beneficiary, ships the tile and is paid by the bank. When the tile lands at the Oakland Shipping Terminal it is delivered to Home Depot. An Accounts Receivable in the amount of $426,000 is generated. The selected Factor finances the receivable by paying off the P.O. Financier and their bank. At the end of 60 days Home Depot pays the Factor the $426,000. The Factor repays itself and sends the remaining funds to California Accents.
- Goods must be pre-sold demonstrated by a confirmed purchase order.
- The purchase order must be unconditional, non-cancelable.
- No consignment or guaranteed sale clause.
- The company issuing the purchase order must be substantial, preferably publicly traded.
- Issuing company must be credit worthy with a track record of paying their bills/invoices.
- Client company must demonstrate a clear profitable business history.
- Client company must have history of selling the goods identified in the P.O.
- Supplier must have proven ability to produce the goods.
- Supplier must be able to meet the ultimate buyer's terms and quality criteria.
- Ready-to-ship, finished goods are easier to finance than non finished goods.
- The purchase order must be for a product not a service.
- The transaction or a contracted series of transactions must be valued at a minimum of $400,000.
- The transaction must be profitable for all parties.
Advantages To Importer
- Provides 100% funding for cost of goods on drop-ship type sales.
- Supplemental source of financing beyond what your bank is able or willing to provide.
- Financing used to fulfill order resulting in increased sales.
- Allows smaller companies to handle big sales through leverage of others money.
- Enables growth without increased bank debt or selling of equity.
- Enables cash purchases resulting in better prices and discounts from suppliers.
- Enables marketing to major new accounts.
- Financing does not increase your debt load.
- Financing can be one-time or series of transactions.
- Purchase Order financing entails the sale of an asset not the acquisition of a loan.
- There is no negative impact on your balance sheet or debt to repay.
- Purchase Order financing may be used with Factoring or Bank A/R financing.
Disadvantages To Importer
- Lenders consider PO Financing a high risk form of financing.
- A highly skilled, specialized P.O. financing lender is required.
- Due diligence is extensive and time consuming.
- Reflecting perceived risk, the costs for this financing can be high.
- Funds or Letter Of Credit will be sent directly to your supplier.
- May need to coordinate security interest in purchased assets/inventory with your bank
Due Diligence Process
The P.O. Finance company will check, review and verify the following:
- The exact deal structure, production and delivery timing and the flow of funds.
- The credit quality and payment history of the issuer of the P.O.
- The credit quality, background, references, reputation of the client company.
- The validity of the Purchase Order.
- The terms and conditions of the Purchase Order.
- The profit calculations for the transaction.
- The shipping documents, and relevant insurance.
- Potential liens, encumbrances, judgments.
- Options for credit insurance.
- The history and credit of your suppliers.
- Title search on the collateral for the funding - product, invoice(s), assets.
- Completed Purchase Order Application Form.
- Copy of Pro forma invoice to buyer.
- Copy of Pro forma supplier's invoice.
- Copy of Pro forma purchase order to your supplier.
- Profit calculations on transaction.
- Most recent corporate Financial Statements (P&L/Balance Sheets).
- Most recent Financial Statement of all Principals of company.
- Most recent company tax return.
- Credit information on buyer.
- Supplier information.
- Copy of Articles of Incorporation or Partnership Agreement.
- DBA filing, if applicable.
- Short biographical history of company, products, markets, objectives, strategy.
- Short biographical history of principals of Company related to experience.
Cost of PO Financing
Each purchase order transaction is individual and unique. Therefore the PO financing pricing varies. Fees range from 4% to 8% of the gross amount of the Purchase Order. Final quote won't be given until a thorough due diligence has been completed. The greater degree the materials being purchased are to be manipulated or changed impacts the complexity, risk and cost of this financing. Costs can vary widely and depend on the following factors:
- credit quality of your customer buyer
- type of goods being produced
- whether the goods are finished or non-finished products
- terms of the Purchase Order
- amount of time from funding to collection
- reputation of your suppliers
Total cost of your financing must include the potential additional costs of Letter of Credit issuance and the costs to finance or factor the accounts receivable period.
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