Purchase order financing pays your supplier for goods against a confirmed order from a creditworthy customer, and is repaid when that customer pays. A line of credit, usually a borrowing-base revolver, advances against receivables and inventory the business already has. PO financing covers the stage a line does not: before goods exist or ship. It costs more, works only for finished goods resold with a healthy margin, and is priced order by order. Use it for specific large orders beyond your capacity; for recurring working capital, the answer is a properly sized revolver.
- PO financing funds
- Payment to the supplier, before the goods ship
- A line funds
- Receivables and inventory the business already holds
- PO financing depends on
- The customer's credit, the supplier's reliability, the order's margin
- A line depends on
- The borrowing base and the business's own finances
- Right use of PO financing
- A specific order too large for current capacity
Two tools for two stages of the cash cycle
A product business's cash goes out in a sequence: pay the supplier, receive or ship the goods, invoice the customer, wait to be paid. A borrowing-base line of credit joins that sequence partway through. Once goods are in the warehouse, the lender advances against inventory; once they are invoiced, it advances against the receivable. Asset-based lenders typically advance 80% to 90% of eligible receivables, and inventory at up to 85% of net orderly liquidation value, or roughly half of cost. See how a borrowing base works.
Purchase order financing covers the step before that. The PO funder pays the supplier, often through a letter of credit or a direct payment, against a confirmed purchase order from the business's customer. The goods are produced and shipped, frequently straight to the customer. When the business invoices, the receivable is usually sold to a factor or financed by an asset-based lender, and the proceeds repay the PO funder, with the business keeping what is left after costs. See how purchase order financing works.
A line of credit lends against what the business has. PO financing lends against what one customer has promised to buy.
Side by side
| Purchase order financing | Borrowing-base line of credit | |
|---|---|---|
| What is financed | Supplier cost of goods for a specific confirmed order | Eligible receivables and inventory, on a revolving basis |
| When money is advanced | Before goods are made or shipped | Once inventory is on hand or invoices are issued |
| Main credit question | Will this customer pay, and will this supplier deliver? | Is the business sound, and is the collateral good? |
| Repaid from | Collection of that order's receivable | Collections generally, then redrawn |
| Pricing | Charged per period the funds are out, order by order; plus the factoring or ABL cost on the receivable | Interest on the drawn balance, plus usually an unused-line fee |
| Relative cost | High | Lower, often much lower |
| Fits | Distributors, wholesalers, importers, resellers of finished goods | Most businesses with receivables or inventory |
| Does not fit | Services, heavy manufacturing or assembly, thin-margin orders | Businesses with no eligible receivables or inventory |
| Reporting | Order documents, shipping and delivery confirmation | Borrowing base certificates, AR and AP agings, field exams |
What PO financing costs and who qualifies
PO financing is priced for its risk. The funder is advancing before any goods exist, relying on a supplier it did not choose and a customer who has not yet received anything. Its fee is usually charged for each period the money is outstanding, so a slow supplier or a slow-paying customer makes the order more expensive. The receivable stage carries its own cost. Over a single order, the combined cost can take a large share of the order's gross profit, which is why funders look at the margin first.
The conditions PO funders commonly set follow from that:
- Finished goods, resold. The business buys a product and sells it on without substantial further work. Orders that require assembly, installation or services carry performance risk funders generally avoid; contract financing addresses some of those.
- A creditworthy customer. The funder is really underwriting the end customer: large retailers, established distributors and government agencies are the usual counterparties.
- A confirmed, non-cancellable order. A letter of intent or blanket order is not enough.
- A supplier with a record. The funder needs confidence the goods will arrive as specified and on time.
- Enough margin. The order has to carry the PO fee, the receivable financing cost and the business's own costs and still leave a profit.
Where the business already has a lender with a blanket lien, the PO funder will need that lender's agreement to take priority over the goods and receivable from the financed order, usually through an intercreditor or a carve-out. That is why a debt schedule and the existing UCC position are on every PO funder's checklist.
Why PO financing is not a substitute for a revolver
PO financing is built for the order a business could not otherwise accept: a new retail account whose first order is larger than the company's entire line, or a seasonal program that needs supplier payment months ahead of the selling season. For that order, a higher cost can be well worth paying, because the alternative is turning the order down.
The trouble comes when a business uses PO financing for its ordinary flow of orders. It then pays PO pricing, and usually factoring pricing, on its routine revenue, gives up margin on every sale, and depends on a funder's approval for each order. A business that needs PO financing month after month usually has a different problem: its line is too small for the business it now runs, or it has no line at all. The fix is a properly sized working capital line, perhaps with an inventory component, and in some cases a letter of credit facility under the revolver to pay overseas suppliers. A letter of credit issued under the line uses availability just as a draw does, so it helps only if the line is sized for it; where it is, the supplier is paid at revolver pricing rather than PO pricing.
A business that has grown out of factoring or repeated PO financing is often a good candidate for an asset-based line; see moving from factoring to a line of credit.
A worked example
A consumer products distributor with a line of 1,500,000 wins a first order from a national retailer. The supplier needs 900,000 before it ships; the line has 300,000 of availability left after the business's normal orders. The order's gross profit, before financing costs, is 360,000.
| Option | What happens | Result |
|---|---|---|
| Turn the order down | No new financing | No cost; the retailer relationship is lost |
| Ask the line lender for an over-advance | Temporary increase beyond the borrowing base | Cheapest if granted; lenders often decline a request this large relative to the line |
| PO financing for this order | Funder pays the supplier 900,000; receivable financed on invoice | Order accepted; financing costs come out of the 360,000 gross profit |
| Resize the line | New or larger borrowing-base facility with an inventory and letter of credit component | Right answer if orders of this size will recur, but usually not in place in time for this one |
The sensible sequence is often both: PO financing for the first order, while the business puts a larger line in place for the repeat orders that follow. See over-advances for the first option and concentration limits for what happens when one new customer becomes a large share of receivables: borrowing bases commonly cap any single customer at 20% to 25% of eligible receivables.
What each asks you to provide
| Purchase order / contract financing | Line of credit / ABL |
|---|---|
| Purchase orders or contracts being financed | AR aging, by customer, with days outstanding |
| Supplier quote or pro-forma invoice for the goods | AP aging |
| Bank statements, last 3 months | Balance sheet |
| Debt schedule / UCC position: existing liens | P&L / income statement; year-to-date P&L through last month-end (optional) |
| Customer list with balance owed by each (optional) | Debt schedule / UCC position: existing liens |
| P&L, if the books are kept (optional) | Inventory report, if inventory is in the borrowing base (optional) |
| Business tax returns, 2–3 years (optional) | Bank statements (optional); business tax returns, 2–3 years (optional) |
The difference in the lists is the difference in the products. A PO funder underwrites the order in front of it; a line lender underwrites the business. PO funders commonly pair with a factor for the receivable stage. Transparent's lender book includes 116 lenders that write factoring and 235 that write asset-based loans and lines, so where the answer is financing for this order now and a larger revolver next, both conversations can start from the same file. See the lender book.
Common questions
- Is purchase order financing a loan?
- It is usually structured as a funder paying the supplier on the business's behalf and being repaid from the order's collection, rather than as a conventional loan. Economically it is short-term financing of one order, priced for the risk of funding before goods exist.
- Can I use PO financing if I already have a line of credit?
- Often, but the line lender will usually have a blanket lien, and the PO funder needs priority on the goods and receivable from the financed order. That takes the line lender's consent, typically through an intercreditor agreement or a carve-out.
- Does PO financing work for manufacturers?
- Generally not for orders that need substantial manufacturing or assembly, because the funder is exposed to performance risk. Manufacturers are usually better served by a line with an inventory component, or equipment and term financing.
- Why is PO financing more expensive than a line of credit?
- The funder advances before the goods exist, relies on a supplier and customer it did not choose, and earns its return on one order at a time. A line lender advances against assets already in hand and spreads its costs across the whole business.
- When should a business move from PO financing to a line of credit?
- When it is financing ordinary orders, not exceptional ones. Recurring working capital needs belong in a revolver sized to the business's receivables and inventory, which costs less and does not need approval order by order.