What Is Purchase Order Financing?
Understand how purchase order financing helps businesses fund the production or procurement of goods for confirmed orders.
Key Takeaways
- Purchase order financing provides funds to pay suppliers or manufacturers based on confirmed customer orders.
- It bridges the gap between receiving a large order and having the capital to fulfil it.
- PO financing is typically more expensive than traditional loans because it carries both production and payment risk.
What PO Financing Solves
Purchase order financing addresses a common growth challenge: receiving a large customer order but lacking the cash to buy raw materials or finished goods to fulfil it. Instead of declining the order or negotiating unfavourable supplier terms, the business obtains financing backed by the confirmed purchase order. The funder pays the supplier directly, the goods are produced and delivered to the customer, and the customer's payment is used to repay the funder. It is pre-shipment finance tied to specific confirmed demand.
How PO Financing Works
A business receives a confirmed purchase order from a creditworthy customer. The PO financing company evaluates the customer's creditworthiness and the transaction's feasibility. If approved, the funder issues a letter of credit or direct payment to the supplier, covering up to 100% of the supply cost. Once goods are delivered and the customer is invoiced, the receivable may be factored to repay the PO funder, or the customer pays directly. The business receives the remaining profit after financing costs are deducted.
Costs and Considerations
PO financing is among the more expensive forms of business finance, with costs typically ranging from 1.8-6% per month. The higher cost reflects the additional risk: the funder is exposed to production risk, delivery risk, and payment risk. Transactions often involve both a PO funder and a factoring company, each taking a fee. Despite the cost, PO financing can be profitable if the order margins are healthy enough. It is best suited for businesses with gross margins exceeding 20-30% to absorb the financing costs.
PO Financing for African Exporters
African businesses winning large export orders from international buyers often face a capital constraint that PO financing can resolve. A Kenyan garment manufacturer receiving a 50,000-unit order from a European retailer may need $200,000 for fabric and production costs. PO financing backed by the retailer's creditworthiness enables fulfilment without the manufacturer having that capital available. African trade finance institutions and fintechs are increasingly offering PO financing products tailored to export transactions, particularly in agriculture, textiles, and light manufacturing.