There are two types of Purchase Orders: Those that are received from customers (called Demand Orders) and those that are issued to suppliers/vendors (called Supply Orders). In today's economy more and more suppliers are demanding full payment for product before it ships. That can place the manufacturer, distributor or importer in a severe cash flow challenge. Purchase Order Financing is a financial tool used by companies to help meet that challenge.
Missed Opportunity Costs
What would happen if you can't get your hands on the product you need to fill a customer order? Might you lose the business? If so, that's a missed opportunity. It means lost profit and a blemish on your reputation.
Missed opportunity costs are a major reason why companies are not as profitable as they could be. In a recent article, Abe WalkingBear Sanchez of A/R Management Group Inc., noted "Missed Opportunity Costs (MOCs) aren't listed on the P&L, but they can have a huge impact on the "bottom line." Once identified and reduced, MOCs contribute to both increased revenue and a reduction of both Fixed and Variable Costs."
Every business operates on the inflow and outflow of cash. Like blood flow, it is that which keeps the business running. The free flow of cash through the business enhances the ability to sell more product and service (which, after all, is why you're in business). If cash flow is constrained then a business may not have the funds it needs to pay suppliers and meet operating expenses. That, in turn, can result in missed opportunities.
The Rack
The Financial Crisis of 2007-2008 created a cash flow challenge for virtually every business. The impact was felt on many levels: General decline in business activity; lines of credit being reduced or rescinded; term loans being called; customers taking longer to pay; suppliers demanding payment prior to shipment; etc.
The last two (customers taking longer to pay and suppliers demanding payment prior to shipment) can be the most severe. When these two happen at the same time your business in on a virtual financial rack - being aggressively pulled in two opposite directions at the same time. Cash flow can dwindle to a trickle and missed opportunities will be everywhere.
Your Place in the Supply Chain
If your company is the first link of the supply chain (raw material provider) or the last link (selling to the ultimate consumer) the virtual financial rack is less severe as you will only be pulled in one direction. In either location the "pay before delivery" policy makes sense and can limit the severity of the impact.
If, however, you're in the middle of the supply chain, the impact can be severe. Why? Because you can't ship to and invoice your customer until you have received and/or produced the product. But you can't take possession of the product (or necessary components) until you pay your supplier. Consequently, unless you have adequate cash flow to cover the supplier demand, you are in limbo. And that could result in missed opportunities.
Options for Handling the Problem
If they are able to qualify, some companies will use a bank line of credit to manage this cash demand situation. Others who cannot currently qualify for a bank line have to wait until payment arrives from customers in order to have the cash necessary to pay their vendors. This greatly slows the flow of business activity. It inhibits growth and profitability.
Purchase Order Financing is another option. Purchase Order Financing is a funding method used by middle-supply chain companies to help manage the cash flow demand of acquiring product. A financial service company will advance the funds necessary to pay the supplier so that you can have access to the merchandise. Funds provided are based on hard Demand Orders from your customer that result in a Supply Order to one or more of your vendors.
It's important to note that companies that offer Purchase Order Financing will not engage if you are purchasing merchandise to increase on-hand inventory. That is to say, they won't pay for merchandise you "hope" to sell. But they will fund the acquisition of merchandise that is pre-sold (i.e., that for which you have Demand Orders from customers).
Some Invoice Factoring companies also provide Purchase Order Financing. Some companies do stand-a-long PO Financing. However, both type of company will require that, if you use PO Financing, you have an Invoice Factoring facility in place. This is because the reimbursement of the PO advance comes directly out of proceeds from your customer invoice.
This, in turn, means that the gating factor to qualify for PO Financing is your ability to qualify for Invoice Factoring. Together Invoice Factoring and PO Financing can solve the cash flow problem and take your company off the financial rack.