Alternatives to a Letter of Credit

The use of letters of credit has become almost commonplace as more companies do business nationally and internationally. A letter of credit provides suppliers with the assurance of a guaranteed payment for their products, provided they meet their clients’ quality and delivery terms. It also frees clients from the risk of having to make upfront payments to their suppliers and ensures that the suppliers only get paid if they deliver what they promised.

However, letters of credit have a catch. They are usually offered by banks and are secured against either a loan or a line of credit. In other words, to be able to obtain a letter of credit, you and your company must qualify for traditional bank underwriting criteria.

But what happens if you can’t qualify because your company is small or new? Or, what happens if you get a purchase order that exceeds your ability to finance a letter of credit? Do you turn it away to the competition?

Fortunately, there is an alternative. It is called purchase order financing. PO funding provides you with the necessary financing to fulfill large purchase orders, provided they are made by credit worthy customers.

As opposed to a letter of credit, the collateral for this type of financing is the actual purchase order. Because of this, purchase order financing is easy to qualify for, since it does not go through traditional bank underwriting requirements. However, you can only use this type of financing once you have an actual purchase order from a customer.

The purchase order financing transaction itself is actually fairly simple and works as follows:

· The financing company or their bank issues a letter of credit in favor of your supplier
· The supplier manufactures the product and ships drop ships it to the buyer
· The buyer receives the product and accepts it. Your supplier gets paid by cashing the letter of credit
· Your customer (the buyer) pays for the order, usually 30 days or so after receipt. The financing company is paid back for its services and all remaining funds are yours.

One of the interesting features of purchase order financing is that in most cases, you have few out of pocket expenses. It’s truly a transaction where you can use other people’s money to grow your business.

Lastly, purchase order financing is frequently integrated with invoice factoring. This is a widely used business financing trick that can help reduce the cost of financing the transaction, thereby increasing your profits.