Factoring and purchase order financing are great solutions for today’s fast growing company. Done right, a company can finance the entire sales transaction – start to finish.
Let’s start at the beginning, the prospect must have a firm order from a customer that meets the credit standards of the factor. The factor also sets the parameters for the amount of purchase order financing based on not only the advance rate established by the factor but also the credit limit to the client’s customer. Essentially the amount of purchase order financing is contingent upon the acceptable credit risk established by the factor so that the factor can take out the amount financed by the purchase order financing, plus fees. That relationship will be established through an intercreditor agreement between the factor and the purchase order finance company.
Purchase order financing steps out beyond traditional collateral. The collateral associated with purchase order financing is the goods, materials, parts, etc. that the client needs in order to fulfill the order. In the world of purchase order financing, the order is fulfilled when it is invoiced, and as a result, creating traditional collateral for the factor.
A key element in evaluating the risk is the client’s gross margin. The larger the margin the less risk perceived by the lender. A higher margin makes it easier to find another buyer if the purchase order is cancelled by the client’s customer and the higher probability of the funds employed by purchase order financing getting repaid. In addition, another key element in risk assessment is the more specialized the product is to the client’s customer, the more risk associated with finding another buyer.
Later we will explore the different types of purchase order financing.