Purchase order financing is an effective alternative for companies that have a large order, but need capital to complete it. A purchase order loan uses the value of a confirmed customer purchase order or contract as collateral. A purchase order loan can allow a company that has received an order with large capital requirements to obtain financing and manage the liquidity demands of the order. Understanding how to use this creative financing tool can help a small business grow.
There are five keys to understanding if the purchase order loan is the right option for a small business.
The first thing the purchase order lender will look at is the strength of the customer contract. They want to understand the particulars of the deal and any potential roadblocks to completing it. Unlike a traditional bank, a purchase order lender is most concerned with the strength of the individual transaction, rather than a company’s credit history. This gives a small business more flexibility in the lending process and allows the loan to be underwritten by the value and risk of the individual transaction.
The second important factor in a purchase order loan is the customer. When a lender assesses a purchase order loan it is assessing the likelihood of final payment of the purchase order. This makes the financial strength and reliability of the purchaser a central element in underwriting purchase order loans. An order or contract from a large, known customer or government entity will carry significant weight with a purchase order lender.
The capital required to complete an order is another important factor in a purchase order loan. The purchase order lender will look at the amount of capital needed and the uses of the capital. Because the loan is underwritten based on the value of the goods or services being sold, it is important that there is a correlation between the capital needed and the underlying value of the product at the end of the transaction.
- Track Record
The track record of a company in completing similar orders is also critical in a purchase order loan transaction. A purchase order lender will want to see that the company has successfully completed similar transactions on time and to the satisfaction of their customer. Because the purchase order loan is based on the order itself, the company’s ability to complete the order is very important. Demonstrating a solid track record of completing similar orders will help a company qualify for a purchase order loan.
The final key factor in a purchase order loan is the amount of margin in the transaction. In order to finance against a purchase order, the order must have sufficient margin to not only pay back the loan, but also to allow for unexpected costs and a fair profit for the borrower. A purchase order lender will want to see that the margin can sustain the financing costs and still provide the company with a reasonable return. If the margin on the order is too thin, it may not be a good candidate for a purchase order loan.
These five keys are critical to determining if a purchase order loan is a good option for a company in need of capital.