Purchase order financing for small businesses

Purchase order financing can help take your small business to the next level. Discover how it works, and what you should look out for.

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Scaling can be a huge problem for small businesses and rapidly growing startups, especially when clients are not paying invoices on time.

That first big order is a huge moment in the history of your company. It’s a time for celebration, and rightly so – just getting to that point is a massive achievement. Quickly though, your thoughts will turn to being able to actually afford to make it happen – how are you going to pay your suppliers the hefty sum they’re requesting? And how will you keep the business going while you wait to be paid by your end customer? This is where purchase order financing comes in.

Essentially, purchase order financing is, in some ways, a special form of invoice finance – the difference is that you can unlock the value of purchase orders instead of invoices. In other words, you can get finance before you deliver the goods, rather than after. This means that you’ll be able to keep money flowing into your business while waiting to be paid by your ultimate customer, helping to fuel the growth of your business.

This guide will break down how purchase order financing works, give you an idea of how much it might cost, and share some advice on choosing the right purchase order financing company for your small business.

If you’d rather dive straight in, then just tell us a bit about your business to receive bespoke quotes from some of the UK’s top purchase order financing companies, all tailored to your specific circumstances.

How does purchase order financing work?

This infographic shows how a purchase order financing agreement might work:

How does purchase order financing work

However, it’s crucial to remember two things:

  1. Different purchase order financing companies go about things in different ways
  2. The process always depends on what payment terms the supplier requests

Finance agreements always depend on the circumstances of the business applying for funding – but with purchase order financing, the supplier’s perspective will also have a significant impact on how the agreement actually works.

It’s possible, for example, that the purchase finance provider may pay your supplier directly without you getting your hands on the money being funded.

Some suppliers will only need a deposit as advance payment, while others may require full payment before a product is shipped.

Others may simply accept a firm commitment to pay, such as a Letter of Credit.

However, while the precise details may change, the core process and benefits are the same:

The funding is always linked to the performance of your business – Purchase order financing is essentially only about getting early access to money that would eventually come your way, rather than getting an extra cash injection into the business. This means you don’t need to worry about fixed repayments you can’t afford, or the burden of a significant debt.

Better supplier terms – Because you will have the funds available to pay your supplier immediately, you’ll be in a much better negotiating position. That means you’ll have a greater chance of securing a lower price or faster production time, boosting the efficiency of your business.

Funding that fuels the growth of your business – This is central to purchase order financing’s appeal – it means you can expand your business much more quickly than being forced to wait for the proceeds of big orders.

Finance that understands your business – The best purchase order financing companies have years of experience helping SMEs achieve their ambitions. They know the challenges you face, and offer flexible financial support to help you overcome them.

Can my small business get purchase order financing?

Exactly which small businesses can get purchase order financing varies from lender to lender, but there is one thing you can be sure of.

Whether you can get purchase order financing will largely depend on the finances of your end customer, rather than your own finances.

This makes sense – the lender will give you the money you need to make the products for the order, but needs to know that your final customer will be able to pay you for those goods, and that it will be able to get its money back.

So, while your financial situation will have some influence on the decision, the focus of the lender’s research will be your customer’s credit history and financial strength.

This means that you should still apply even if you have a poor credit history – as long as you have a reputable end customer in place, then you still have a good chance of getting purchase order financing.

How much does purchase order financing cost?

There is no such thing as a standard cost for purchase order financing – the cost will always be set by the purchase order finance company, based on when the money forwarded is likely to be repaid and the financial strength of the end customer.

To give some idea of how much purchase order financing could cost, Catalyst Finance gives the following example on its website:

A business that wanted to borrow £50,000 for 45 days would pay back a total of £52,025.

So, if we break down that example:

Under Catalyst’s terms, up to 80% of the order amount is advanced, so we’ll assume that this £50,000 is 80% of the total order value.

This would mean that the business would have received an order worth £62,500.

It would then have required funding to pay its supplier(s) and would need to know when the end customer would pay for the goods – in this case, that would be within 45 days of the order (including manufacturing time).

£50,000 would then have been advanced to cover the bulk of manufacturing costs.

When the goods have been delivered and the end customer has paid up, the business then repays the amount advanced (£50,000) and the lender charges (£2,025), so £52,025 in total.

So, the cost of the financing is £2,025.

This cost would be heavily impacted by how long the financing is required for. Catalyst and other lenders offer flexible financing that means lower fees if the money is repaid quicker, but higher fees if it takes longer than expected to repay.

Remember though – this is only an example. To get a much better idea of how much purchase order financing could cost for your small business, simply tell us a bit about your circumstances to receive bespoke quotes from some of the UK’s leading purchase order financing companies.

How does purchase order financing work with invoice finance?

Generally speaking, purchase order financing is more expensive than invoice finance.

So, it’s often the case that businesses will take out invoice finance to pay off purchase order financing.

This is a little bit complicated, but there are two big advantages to doing this.

  • It lowers the overall cost of financing – If businesses are only able to pay the purchase order financing company when they are paid by the end customer, then they have to pay purchase order financing rates for a long time. If, however, they can take out invoice finance as soon as they submit an invoice to that end customer, they can use the invoice finance funds to pay off the purchase order financing debt, and the overall financing would cost less than if you just used purchase order financing.
  • It boosts your cashflow – If you use purchase order finance and then invoice finance, you get two inflows of cash into your business – one when you receive the purchase order and agree purchase order finance, and the other when you get an invoice and sort out invoice finance. This means that money keeps flowing into your business, instead of you having to wait a longer period of time for a larger sum to arrive all at once, and having to manage overheads and other fixed costs in the meantime.

The flipside is that invoice finance can be harder to get than purchase order finance, especially for small businesses with a poor credit history. If you apply for invoice finance, the finance company will carefully research your company and look into how quickly you’re paid   by your clients, so they can work out what terms they should offer you.

If, however, you’re in a strong position and considering this option, make sure you check if your chosen lender offers both purchase order financing and invoice finance, as this will simplify the whole process. Most lenders will be able to provide both services, but it’s really important to have all this agreed in advance before you sign on the dotted line.

For more info on invoice finance, check out these three pages:

  • Our detailed guide to how much invoice factoring costs explains all the things that can affect the cost of invoice finance, and discusses the hidden charges you should look out for
  • For an in-depth breakdown of the top invoice finance firms, head to our guide to the UK’s best invoice factoring companies, which also gives you load of information on what you should look at when comparing invoice finance companies
  • Finally, if you’re worried about your clients knowing you’re using invoice finance, then our explanation of how confidential invoice discounting works is a must-read – it tells you how you can use invoice finance, and stay in control of your client relationships

If this sounds like the ideal financing solution for your small business, it’s easy to get started. Simply tell us a few key details about what you’re looking for, and we’ll give you bespoke quotes from some of the UK’s best purchase order financing companies. Then, just make sure you ask about their invoice finance options when you get in touch with them.

How to choose a purchase order financing company

It’s human nature that, whenever you’re comparing different options, your eye will always be drawn to the one that’s cheapest.

???? However, what you really need to think about here is value for money, and which company is the right fit for your business. Simply going for the cheapest quote could harm your business for some time to come.

⌛ Ideally, you want a company that you can form a long-term relationship with – one that you can return to again and again whenever you need help financing the growth of your business.

???? So, try to find a financing company that has experience working with businesses like yours, and ask how it has previously helped businesses in your sector.

???? Customer service is also hugely important, so make sure you do your research. Check review sites like Trustpilot to see what sort of experience you can expect. Ask the company directly as well whether you can expect a dedicated relationship manager, or whether they’ll make the effort to visit you in the field.

???? This is standard advice for any business document, but is doubly important for financial agreements – read the contract. That means every word. That means asking about anything you don’t understand. That means knowing exactly what you’re signing up to before you put pen to paper (or, most likely, applying a digital signature to a PDF in these unprecedented times). Yes, it’s a pain, and yes, it’s probably written in a mix of latin and legal jargon – but you need to know, for example, whether you’ll be charged a lower fee if you pay back the money lent you quicker than expected, or how much it might cost you if you’re not able to pay back on time.

???? Finally, if you want a long-term partner, then look for a finance company that has stood the test of time. If it’s already been around for decades, then the chances are high that it will be there to support you as long as you need it to.

Final thoughts

Purchase order financing can be a little tricky, but it can really help startups to grow rapidly and support the expansion of small businesses.

Just remember these five key points:

  1. No extra debt

Like invoice finance, you’re not loading extra debt onto your company – you’re just getting a bit of help making big orders happen.

  1. A boost to your cashflow

This can be hugely beneficial to your cashflow, which is the eternal headache for many small businesses. With purchase order financing, you get money coming in shortly after you secure an order, rather than having to fund payments to suppliers etc. yourself, and then only getting money into your business much later down the line.

  1. Sustainable business growth

This improved cashflow means that it’s much easier to gradually expand your business, especially as purchase order finance means you get financial support that understands your business. You also get the leverage to negotiate better terms with your suppliers.

It’s also a great option for businesses with a poor credit history – as long as you have a reputable end customer, you should still have a very good chance of getting purchase order financing.

  1. Purchase order financing + invoice finance = greater benefits

If your business is in a strong position, then you really should consider combining purchase order financing with invoice finance for a comprehensive business finance solution. While this does make things a bit more complex, most purchase order finance companies also offer invoice finance, and the rewards are definitely worth it – you’ll get a lower overall cost, and much smoother flow of cash into your business.

  1. Find the right fit for your business

When comparing purchase order finance companies, it’s absolutely crucial that you look beyond the cheapest quote and try to find a company that can be a long-term partner for your business. When considering your options, ask how they have previously helped companies like yours and what sort of customer service you can expect, as well as checking out their reviews on sites like Trustpilot and going through the terms and conditions with a fine-tooth comb. Companies with long, strong track records should be high up your list, as this is a pretty good sign that they know what they’re doing and will be there for the long haul.

To get started, tell us a bit about your circumstances, and we’ll send you bespoke quotes from some of the UK’s top purchase order finance companies – all tailored to your needs.

With the right company, purchase order financing can play a huge role in scaling your startup, or taking your small business to the next level.

Good luck!

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Written by:
Alec is Startups’ resident expert on politics and finance. He’s provided live updates on the budget, written guides on investing and property development, and demystified topics like corporation tax, accounting software, and invoice discounting. Before joining, he worked in the media for over a decade, conducting media analysis at Kantar Media and YouGov, and writing a wide variety of freelance pieces.
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