Purchase Order Financing

Frequently Asked Questions on Purchase Order Financing
  • Who can avail of purchase order (PO) financing?

    PO financing can be availed by any business purchasing a raw materials or equipment to fulfil a large order. The financing can be made against invoices for goods already purchased by the SME or against a proforma invoice issued by a vendor who will supply the goods being financed. In case of the former, the funds are credited directly into the SME’s bank account whereas, in case of the latter, the lenders on the Artha Credit platform may prefer to make payment for the purchase directly to the goods supplier. Hence the loan request should ideally be raised before the goods have been purchased and paid for.

  • Is collateral security required for PO financing?

    The lender may have a charge on the receivables due from the SME’s customer which raised the purchase order. In addition, the goods being financed through the purchase may be hypothecated to the lender. In case of the former, the lender may require the payment under the receivables raised on the customer be directly credited to the SME’s account with the lender. Lenders may also require additional collateral from the borrower depending on the risk appetite and internal guidelines of the bank.

  • How much loan can be raised?

    SMEs can raise funds up to a maximum of 70-80% of the outstanding value of the purchase order.

  • What is the maximum tenor of purchase order financing that can be availed through the Artha Credit platform?

    A borrower can avail a PO financing facility for a maximum tenor of 1 year from the date of disbursement. However, the actual tenor of the loan will depend on the goods (raw material etc.) being purchased and production period, the working capital cycle of the industry, credit period given to customer (purchaser), the amount of the loan, the market standards regarding similar loans, the risk appetite of the lenders and other considerations that the lenders may have in determining the terms of the loan.

  • Which are the common industries that use purchase order financing?

    Typically, the types of businesses that might use PO financing include distributors, resellers, wholesalers, businesses with heavily seasonal sales patterns, businesses with tight cash flow who have a need to purchase materials to fulfilling orders.

  • What are the advantages of purchase order financing?

    PO financing allows a SME the money required to fulfil an order which would otherwise be difficult given the large initial outlay of funds required. The lender also acts as a collection agency, so the SME does have to worry about trying to track down payments from their customers.

Purchase Order Financing process explained
  • What Is purchase order financing?

    Purchase order, or, “PO financing” is an arrangement where a lender agrees to give a SME enough money to process a customer’s purchase order. By using the facility to fund purchase orders, SMEs (suppliers) can fulfil their customers’ needs while continuing to grow their operations. Lenders find it convenient to lend against a PO because there is certainty of revenue for the client, so effectively, the lender is advancing a loan against a future cash flow of the SME.

    In some cases, PO financing will cover an entire order while in other cases they may only finance a portion of it. When the SME is ready to ship the order, the lender collects payment directly from the customer. After repayment of the loan amount along with the accrued interest, the balance funds can be credited by the lender back to the SME. For SMEs requiring urgent access to cash needed to fulfil a large purchase order that comes in, PO financing is an ideal solution.

  • Who uses purchase order financing?

    SMEs need to acquire raw materials, equipment and other ancillary materials to meet a PO issued by a customer. In case of a large PO, the SME will need to make substantial financial outlay to meet the customer’s order requirements. In many cases SMEs do not have adequate working capital to complete the order and they need funds against the PO. This is more common in industries where the working capital cycle is long and the cost of raw materials or equipment may be very expensive. Here are a few examples of customers use of line of credit for PO financing:

    • “Buy materials necessary to deliver a project”
    • “Purchasing a new piece of equipment”
    • “Purchase extra inventory for a seasonal product”

  • How does purchase order financing work?

    On receipt of a Purchase Order from its customer, the SME identifies the goods (raw materials or equipment) which it needs to purchase to fulfil the order. Since the cost of purchasing these goods is usually high, the Business would typically prefer to fund the purchase through a PO financing facility. The SME would either purchase the raw materials etc. before requesting for financing or ask his supplier to raise a proforma invoice which is then submitted to the lender along with the PO received from the customer to avail the loan. The SME may also offer any additional collateral to the lender apart from a charge on the receivables against the purchase order issued.

    The lender would assess factors such as the credit worthiness of the customer (PO issuer), the track record of the SME borrower or whether the Purchase Order is non-cancellable or not. The lender would, also ensure to keep a margin and finance only a portion of the PO value – typically not more than 70-80% of the value of the PO. The lender usually gets repaid by receiving the funds directly from the customer. The bank would deduct the loan amount along with interest accrued and any other charges as applicable. Post these deductions, any excess balance received is credited back to the SME. Thus, the loan repayment is typically at maturity of the PO invoice.

  • Why is Purchase Order Financing helpful?
    Advantages of PO financing

    PO financing enables quick availability of finance when a SME receives a large order all of a sudden.

    • Relatively inexpensive – PO financing is considered lower risk because the loan is tied to verifiable underlying transaction and supporting invoices etc.
    • Easier to manage loan application – Additional information sought by lenders and collateral requirements are far less than for traditional loan applications for a line of credit.
    • Ease of collection – The lender would track and follow up for the collection of payment against the Purchase Order thus reducing the SME’s effort and time spent on collection.

    Disadvantages of PO financing

    Though PO financing is considered one of the better sources for credit from lenders, they have their downsides. A few disadvantages of PO financing are:

    • Focus on manufacturing industries – PO financing does not work for service-related industries.
    • Focus on large orders only – Typically PO financing is offered only to SMEs who have secured a large order from a particular customer. It is not helpful in financing small orders from multiple customers.
    • Limited financing – The loan amount covers only the cost of purchasing raw materials or equipment. It does not cover cost of other expenses related to the manufacture and hence the margins are quite high compared to other products.

  • Factors on which a PO financing depends:

    Different lenders have different criteria for approval. On average, however, SMEs that qualify for PO financing usually tend to have the following traits in common:

    • Large trading companies which buys products from suppliers and resells them to the customer.
    • The value of the Purchase Order tends to have a minimum size.
    • The gross margin on the transaction needs to be at least 20%, if not more.
    • The customer issuing the PO needs to be creditworthy. Lenders financing POs are likely to conduct a detailed credit check on the customers to determine their creditworthiness - business credit checks, whether the customer has a record of timely payments, bankruptcies, or litigation etc.
    • The SME requesting for the financing needs be reputable with a track record of delivering orders on time, made to customer specifications. The business also needs to have a good reputation and be in good financial standing.
    • The transaction needs to be non-cancellable.

  • Documents required to avail Purchase Order Financing

    Here is a list of documents required by the lender to provide PO Financing facility:

    • Address Proof of business and business Owner
    • Business Registration Proof and ID proof of Owner
    • Sales Tax registration certificate
    • Filed Sales Tax Returns for 1 year
    • Income Tax ID for the business and business owner
    • Six months’ bank statement for the business and the business owner
    • One years’ Audited financial statements of the business
    • Purchase Order received from the customer
    • Invoice issued by the SME’s supplier which needs financing
    • Documents pertaining to any collateral being offered (if applicable)