The general description of Purchase Order Finance is easy enough to understand. Let’s say you have a customer with a purchase order for $100,000 worth of items. The problem is that you don’t have the capital to pay suppliers for the materials needed to make those items. This is where purchase order finance lenders come in.
They verify the authenticity of the purchase order and check that the customer can pay for the merchandise. They investigate the capabilities of your supplier, and they check your capabilities as well.
If everything’s good, they then approve your request for purchase order financing. Your suppliers get paid, your customer gets their order, and you and the lender get the payment from the customer. The lender gets their cut, while you still enjoy a nice profit.
But the general description doesn’t’ touch on the specifics and some of the details are truly important. When you have your discussions with PO finance lenders, here are some details you need to find out:
- How do the lenders pay your suppliers? PO finance lenders don’t actually give you the money directly. Instead, they pay the suppliers on your behalf. This is usually done through letters of credit.
A letter of credit is a document issued by a bank, which guarantees a payment if specific conditions are met. For example, the supplier gets paid if they actually deliver $100,000 worth of items according to a specified delivery schedule. The letter of credit is given before the delivery, and once the delivery is done then the suppliers get their money.
This is a very safe method of payment for your lender, which is why when foreign suppliers are involved this is the payment method usually used.
But the problem is that some of your local suppliers may not be quite at ease with letters of credit. That’s because they can easily lead to complications, such as disagreements as to whether certain conditions are actually met. From the point of view of your supplier, they may send your supplies and they may not actually get their payment.
So ask your lender if they can also do wire transfers or even make cash payments. If they don’t, this can really limit the available suppliers you can use.
- What about prepayments? Many suppliers guard against not getting any money at all by requiring a deposit before they work on a given order. But some finance companies refuse to make a deposit. That means you need to ask if your lender can accommodate these requirements, should your suppliers ask for a deposit.
- Can they deal with guaranteed payment clauses? This is when your customer includes in your sales contract a guarantee that if they only sell X number of items, then they can return the unsold items to you and get a full refund for them (it’s considered a consignment).
You may negotiate better terms for these clauses, but it will help a lot if the PO finance lender has some experience with this kind of arrangement.
Working with purchase order finance lenders means you have to know all the details especially the ones we’ve mentioned above. They’re not as unimportant as you think.