How to finance your importing business with Purchase Order Funding
Most importers have seen their businesses grow dramatically in the past years. The drop in the cost of overseas manufacturing coupled with the insatiable appetite of US consumers for more and cheaper ...
Let me give you an example. Let’s say that your company gets a very large purchase order (PO) from your best customer. You, of course, would go to your supplier and try to fulfill the order. However, if your supplier is unwilling to extend you terms, you may need to post a letter of credit or similar instrument. This is where small and mid size importing/exporting companies run into problems. If they cannot post a letter of credit, they will not be able to fulfill the order and will lose the business. This is also where purchase order financing can help you.
What is purchase order financing?
Purchase order financing is a tool that can help you finance orders that you cannot afford to fulfill. It allows you to take large orders from great clients and deliver them, without using any (or little) of your own funds. PO financing lets you grow your business using other people’s money. It’s a great tool to take your business to the next level.
The basics of purchase order funding
A po funding transaction is fairly simple. Once you have or are close to having a purchase order from your customer, you approach the PO financing company. The PO financing company then provides financing for the transaction, enabling you to purchase the goods from your supplier and deliver them to the customer. Once the goods are received and verified, the PO financing pays your supplier on your behalf. Payment to your supplier can be provided in a variety of forms, although it is commonly done using a letter of credit. Once the goods have been received, you send an invoice to your client and wait for payment. Once your client pays the invoice, the transaction between the PO funding company and your company is settled. If that transaction was structured properly and if your margins were good, this transaction should have required little if any out of pocket expenses from your company. This is why PO financing is so powerful.
The cost of PO financing
The cost of PO financing will be based on a number of criteria, including your experience in the industry, the complexity of the transaction and the credit worthiness of the end customer. A rule of thumb for the industry is that a transaction must have profit margins of at least 20%, or better, to be affordable. That will allow you sufficient funds to cover the cost of PO funding and still realize significant profits.
Cost reduction tricks
The main cost driver in purchase order financing is risk. The risk in the transaction is reduced dramatically substantially once the product is delivered and an invoice is generated. A common trick to reduce the cost of the transaction is to factor the invoice, and use the factoring proceeds to close the purchase order financing part of the transaction. Since accounts receivable factoring is cheaper than PO financing, this little trick can reduce the total cost of the transaction by a few points. To capitalize on this cost reduction trick, you should be sure to work with a factoring company that also does purchase order financing. That will enable you to close the purchase order funding component seamlessly.
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