A small business owner's guide to purchase order financing

What exactly is purchase order financing?

Purchase order financing is a type of funding that allows small businesses to fulfil customer orders by providing upfront capital to pay suppliers for the necessary materials or products.

Essentially, a lender will provide the necessary funds to purchase the inventory needed to fulfil a customer's purchase order, and the small business will repay the lender once the goods are sold and payment is received from the customer.

In South Africa, purchase order financing is becoming increasingly popular as a way for small businesses to overcome cash flow challenges and take advantage of growth opportunities.

In a nutshell: this is how it works

So, let's say your small business gets a big order from a customer but you don't have enough cash flow to pay your supplier for the goods needed to fulfil the order. That's where purchase order finance comes in!

Basically, a purchase order financing company provides you with the funds you need to pay your supplier for the goods required to fulfil the order. The supplier then delivers the goods directly to your customer. Once the customer pays for the order, the financing company gets paid back with interest and deducts their fees before passing on the remaining funds to you.

It's like a financial matchmaker connecting you, your supplier, and your customer to make sure everyone gets what they need. And as a small business owner, you get the peace of mind and cash flow you need to fulfil the order and keep growing your business.

Great, but what exactly can it do for you? Let’s take a look.

If you're a small business owner, you know how difficult it can be to secure funding to fulfil large orders. This is where purchase order financing comes in. It allows you to take on bigger orders than you would normally be able to handle, giving your business the opportunity to grow and expand.

Plus, since the financing is tied to your purchase orders, you don't have to worry about putting up collateral or having a perfect credit score. It's a great way to keep your cash flow positive and keep your business moving forward.

How purchase order finance differs from other forms of business financing options

Unlike traditional financing options, such as bank loans, purchase order financing focuses on the actual orders your business receives. Instead of relying on your credit score or collateral, the finance company evaluates the creditworthiness of your customers and provides you with the funding needed to fulfil the orders.

This means that you won't have to turn down big orders due to a lack of funds or worry about making repayments on a loan. It's like having a financial wingman that's always got your back, ensuring that you can grow your business without the stress of financing constraints.

Here’s what a typical purchase order finance process looks like

1. You receive a purchase order from a customer but don't have the funds to fulfil the order.
2. You apply for purchase order financing from a lender, providing them with the purchase order and any other relevant documents.
3. The lender verifies the purchase order and the creditworthiness of your customer.
4. If approved, the lender provides you with the funds needed to fulfil the order, typically up to 80% of the purchase order value.
5. You use the funds to pay your suppliers and fulfil the order.
6. Once the customer pays the invoice, the lender deducts their fees and releases the remaining funds to you.

Pros and cons of purchase order financing

Advantages:

• Access to working capital: Can provide small businesses with the necessary cash flow to fulfil orders and grow their business without putting undue strain on their finances.
• No need for collateral: Unlike other forms of financing, POF is secured by the purchase order itself, meaning there's no need for collateral to secure the loan.
• Improves creditworthiness: Can help businesses build their credit score and increase their creditworthiness, which can be beneficial when applying for other types of financing in the future.
• Flexible: Is a flexible form of financing that can be tailored to suit the needs of each individual business.
• Can help businesses win larger contracts: Small businesses can take on larger orders and contracts that they might not have been able to fulfil otherwise.

Disadvantages:

• Higher interest rates: Can come with higher interest rates than other forms of financing, which can add up over time.
• Limited to certain industries: Is typically only available to businesses that operate in certain industries, such as manufacturing or distribution.
• Limited to creditworthy customers: Is only available if the customer has a good credit history, which can limit the number of businesses that can qualify for this type of financing.
• Complexity: The process of applying for and obtaining POF can be complex and time-consuming, which can be a barrier for some small businesses.
• Limited to confirmed purchase orders: Only available for confirmed purchase orders, meaning businesses can't use this financing option for speculative orders or future sales.

Eligibility requirements for businesses to qualify for purchase order financing

• Have a purchase order from a reputable customer.
• Be a registered business in South Africa.
• Your business should have a track record of delivering quality goods.
• Have a reliable supplier network that can fulfil your orders.
• Your profit margins should be high enough to cover the cost of financing.

Before applying, have these documents ready:

• Purchase order or contract from a creditworthy customer
• Invoices or other documentation verifying the cost of goods from the supplier
• Articles of incorporation, business registration, or other legal documentation proving the existence of the business
• Financial statements or tax returns to demonstrate the financial stability of the business
• Bank statements or other proof of cash flow
• Personal identification and proof of address for business owners and/or directors.

How to choose a POF lender

• Interest rates and fees: Make sure to compare the interest rates and fees charged by different lenders. Consider the overall cost of the finance, including any hidden fees or charges.
• Funding amount and flexibility: Check the minimum and maximum funding amounts offered by the lender and ensure they meet your business needs. Look for a lender who can offer flexible funding solutions tailored to your specific requirements.
• Approval process: Understand the lender's approval process and how long it takes. You don't want to miss out on a business opportunity because the approval process is too slow.
• Reputation: Research the lender's reputation in the market, read reviews, and ask for references. Ensure they have experience working with businesses similar to yours.
• Customer service: Look for a lender that provides excellent customer service and support. You want a lender who is responsive and can help you navigate the funding process.

5 leading providers of purchase order finance in South Africa

1. Merchant Factors - provides flexible funding solutions for small and medium-sized businesses with a focus on supply chain finance, debtor finance, and trade finance
2. Lulalend - offers fast and flexible financing solutions for small businesses, including purchase order finance. They specialize in short-term loans and lines of credit to help businesses manage cash flow.
3. Bridgement - provides small businesses with access to short-term finance to help manage their cash flow. They offer a range of funding solutions, including invoice financing, supplier finance, and purchase order financing.
4. Sasfin - offers a range of business finance solutions, including purchase order financing. They specialize in helping small and medium-sized businesses grow and achieve their financial goals.
5. FirstRand - provides a range of finance options for businesses, including purchase order financing. They have a reputation for offering innovative financing solutions tailored to the needs of businesses in South Africa.

Your POF frequently asked questions answered

Q: Is Purchase Order Financing only for small businesses?
A: No, POF is available to businesses of all sizes. However, it is more commonly used by small and medium-sized businesses that have limited access to traditional financing options.

Q: What are the advantages of using Purchase Order Financing?
A: POF allows businesses to fulfil larger orders and take on more clients without the risk of cash flow problems. It also provides quick access to capital and can be a good option for businesses with short-term financing needs.

Q: What are the disadvantages of using Purchase Order Financing?
A: The main disadvantage of POF is that it can be expensive. Lenders often charge high fees and interest rates, which can eat into a business's profit margin.

Q: Can I use Purchase Order Financing for any type of product or service?
A: POF is typically used for tangible goods, but it can also be used for services that have a clear, measurable value.

Q: How much funding can I get through Purchase Order Financing?
A: The amount of funding you can receive through POF will depend on the size of the order you need to fulfil and the lender's policies. Typically, lenders will provide funding for up to 80% of the value of the purchase order.

Q: How long does it take to get funding through Purchase Order Financing?
A: The time it takes to get funding through POF can vary depending on the lender and the complexity of the transaction. However, most lenders can provide funding within a few days to a week.

Q: What happens if the customer doesn't pay?
A: If the customer doesn't pay, the business is responsible for repaying the lender. This can be a risk, but most lenders will conduct due diligence on the customer's creditworthiness before approving the financing.

Q: Is Purchase Order Financing right for my business?
A: Whether POF is right for your business will depend on your specific needs and financial situation. It can be a good option if you have short-term cash flow needs and need to fulfil large orders quickly. However, it's important to weigh the costs and risks against the potential benefits before making a decision.

Q: Is purchase order financing suitable for all types of businesses?
A: No, purchase order financing is best suited for businesses that are unable to fulfil large orders due to a lack of funds, and have purchase orders from reputable clients.

Q: How long does it take to get approved for purchase order financing?
A: The approval process varies from lender to lender, but generally, it takes a few days to a couple of weeks to get approved. It depends on the complexity of the transaction and the completeness of the application and supporting documents.

As a small business owner in South Africa, purchase order financing can be a valuable tool for managing cash flow and taking on larger orders. With this type of finance, you can access the funds you need to fulfil customer orders without waiting for payment.

Keep in mind that while purchase order finance has its advantages, it also has some drawbacks to consider. When choosing a provider, be sure to consider factors such as their fees, experience, and reputation. By meeting the eligibility requirements and providing the necessary documents, you can secure the funding you need to take your business to the next level.

Our collection of purchase order finance companies is a great place to start your search for the ideal partner and while most business owners tend to gravitate toward their banking partner, a smaller credit provider may just be able to offer you more suitable options and better terms, so consider all your options and speak to a business consultant or advisor to help you make the right choice.