You have just received a large sales order for your designs, a great opportunity for you, and you cannot possibly fill it because your small business is low on cash or below water to purchase supplies in order to fill the order. So what are you going to do? Consider the hurdles:
• Purchase the goods you will need from your suppliers, with upfront money you don’t have
• Get the money you need from a bank, but without a long track record or history of impressive financial statements
• Accept not receiving payment from your customer until 30 or 60 days after they received shipment, creating a cash flow gap you can’t manage.
If you turn down the order, you may lose your customer to a competitor and you will lose out on your opportunity to grow the business. You will have to get creative.
There is a way to remedy this situation and that is through purchase order financing. Purchase order financing (or funding) looks to the credit worthiness (and good fashion sense) of your customer. Your creditworthiness or the fact that your business may be underwater is not an issue; your customer’s creditworthiness is. A purchase order financing company works with your supplier or manufacturer to get your garments produced on time. It also works with your customers to ensure payment of the invoice.
Here is how it works. A purchase order loan is a fee-based, short term loan and there is no interest charged. To see if the loan can be made, the purchase order lender investigates the credit history of your customer. If the customer has a good, solid track record of paying its bills and has the cash flow to pay for the goods it has ordered, a loan can be made. But there is some verification required on your part. You must know your costs for the product and the gross margin attributed to that product. If you have a gross margin of 25% or more, then it is possible to execute a purchase order transaction. This means that you will have enough room to make a meaningful profit.
If your customer has good credit, the purchase order lender delivers a letter of credit to the manufacturer that guarantees payment for the needed goods. The factory then makes the products, and a third party verifies that the order is complete. The factory gets paid and ships the goods off, usually to a third party warehouse. It is rare that you would take delivery of the goods; they are usually shipped directly to the customer.
When the bill is paid, the funds go to the purchase order lender, which subtracts its fee and sends the remaining profits to you. This fee may amount to 4%.
There may be a hitch to the receivables portion of the transaction. If you have given the customer payment terms of 60 or 90 days, another type of specialty lender, a factor lender, comes into play to provide immediate payment to the purchase order lender. The factor lender buys the outstanding invoice at a discount and then waits and collects the full amount owed later, pocketing a profit in the process. Meanwhile, the purchase order lender and you get paid immediately. Thus, with this good news comes the bad, there is another layer of costs involved with factoring but this may be required by the purchaser order lender.
Here is what you do. You provide a valid purchase order with a credit worthy customer and the expertise to manage the process. The purchase order lender provides payment to your supplier, allowing your goods to be produced and shipped. Payment is typically completed through issuing letters of credit and ultimately the payment of the invoice.
Benefits to using a purchase order lender. While you stand to get 94-97% of the profit (implies a 25% gross margin), you are getting money to help you grow your business. You can use a purchase order lender many times; there is no restriction. The transaction does not show up on your balance sheet (off balance sheet financing) as a liability, thus working capital is not impaired by this transaction and your total debt to equity ratio is not increased.
Who, other than the fashion industry, use purchase order lending? Importers, exporters, wholesalers, assemblers, distributors and manufacturers, who are experiencing rapid sales growth, capital constraints, sales volatility, seasonal sales spikes, high development costs, stretched credit, new product launches can take advantage of this type of financing. Industries that can benefit are electronics, housewares, sporting goods, toys/games, furniture, food products, hardware and industrial goods.
To find a purchase order company you can look at industry information and the yellow pages. Make sure you check references first.
Look for my forthcoming article on “Factoring” in the next few weeks.
Margo Moore teaches BE 261 Starting a Small Business, CEO 001 Setting a Course for Your Business, CEO 002 Knowing Your Market, and CEO 003 Formulating Your Financial Strategy.