“What exactly is purchase order finance?”
When I was first starting out in the P/O finance business more than 25 years ago, I heard that question all the time. Often times I needed to cite examples of deals we were doing in conjunction with traditional lenders in the industry, as well as details of our finance solution and how it benefited the client and senior lender. Very few lenders or operating companies knew what the value proposition of utilizing or partnering with a P/O finance company was, so education was crucial.
Fast forward to today, and although many more people are familiar with the term “P/O finance,” many still do not know the value of working in conjunction with an established purchase order finance company to help grow sales, win more business or expand current client relationships.
P/O finance is performance-based financing, not traditional financing. It’s not asset-based financing, since the assets have not yet been created when a P/O finance company begins its funding. A purchase order is not an asset. It is simply an indication of an interest to purchase. There is no such thing as a non-cancellable purchase order unless the terms are specifically signed as such.
Financing inventory to fulfill orders is an art, it’s not a science. And it should be handled in a disciplined manner from beginning to end.
An established P/O finance company can bring a great deal of value to any factor, asset-based lender or bank. Working in conjunction with a purchase-order finance company allows lenders to offer a financial solution that provides additional liquidity to help win new customers or help an existing customer grow sales beyond their current balance sheet or asset-based formula. These financiers help clients take advantage of growing sales by financing the purchase or manufacture of additional inventory to fulfill increasing sales without having to raise equity to take advantage of the growth.
A dedicated purchase-order finance firm does not compete with the asset-based lender or factor. Rather it enhances their lending relationships. A P/O finance company helps traditional lenders and their customers by assisting them to increase sales without the lender taking on extra risk outside their standard lending formula. P/O financing is a solution that provides capital to enable customers to acquire or manufacture inventory in excess of what their balance sheet traditionally offers. The additional inventory helps sales and profits grow, and thus increases the company’s balance sheet, profits and liquidity.
P/O finance companies can also offer a level of oversight and security for factors and asset-based lenders. Primarily, they do this by keeping a watchful eye on what becomes the lender’s collateral. This includes monitoring the inventory and deliveries to assure performance under the P/O requirements of timely delivery, quantity and quality. Since P/O financing creates further collateral for asset-based lenders and factors to provide more of their own financing, a P/O finance company’s oversight protects the lenders they are working in conjunction with. This watchfulness offers assurances that traditional lenders often do not have in their typical finance relationships.
P/O finance companies work hand-in-hand with other lenders, utilizing an intercreditor agreement to divide assets. It is important that everyone is on the same page and that each party is in agreement on the other’s role. Typically, a P/O finance company assumes the performance risk to fulfill orders that could not be filled without the additional capital. The P/O finance company finances the inventory to complete the orders, and then the factor or ABL advances on the receivables or inventory once created–paying off the cost of goods to the P/O finance company. This is great benefit to the customer since each finance partner is an expert in their field and the customer is getting the best offering of P/O finance and ABL or factoring. Neither finance party is being asked to do anything they are not comfortable doing; they simply work together to offer the customer the most liquidity to help grow profits.
An example of a relationship between King Trade Capital and our colleagues in the asset-based lending or factoring world would be a situation where an existing client of a factor or ABL establishes a big new customer relationship. The client's current sales are easily financed under the factoring or ABL formula; but, with the new relationship from a large national retailer, they are going to need a lot of capital to pay for the inventory in order to fill the orders. The opportunity is great for the client’s business but they need a solution to help finance the increased inventory to fulfill the larger orders. The ABL lender wants to help but the orders are much larger than the asset base so they contact a P/O finance company to discuss their new circumstances. A P/O financer like King Trade can quickly assess the finance solution to allow the customer to acquire the inventory needed to fill the much larger orders. An intercreditor agreement with the senior lender is then established to provide the additional purchase-order financing. This will assist the company in manufacturing or purchasing the goods to fill larger orders and, once the sales are invoiced, the customer borrows from their ABL against their collateral or factors their receivables to pay down the P/O finance facility. This can happen as a one-off transaction, or on a repeated basis all year long. P/O financing can help until the company’s balance sheet grows to a sufficient size to allow the ABL to be able to provide acceptable liquidity for the higher sales volumes.
Over 25 years in business I’ve seen countless examples of increased sales and profits for clients as a result of P/O financing in conjunction with traditional lenders. Those lenders bring us in to help because they know of the value added to their customers’ sales and realize if their clients’ sales grow it helps successfully grow the lenders financing relationship as well.