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The difference between purchase order financing and invoice factoring

Both purchase order (PO) financing and invoice factoring are designed to help businesses that have sales outpacing their incoming revenues.

But they manage cash flow in two different ways.

If you are a small business in need of financing to stabilize your cash flow, it's important to identify when to use invoice factoring and when to use purchase order financing.

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Purchase order financing

Basically, this is an advance of money that goes to your supplier so that you can fulfill a customer order. It's best used when you need capital to fulfill a customer order. Cost is 1.8 percent to 6 percent for the first month and additional costs thereafter.

Minimum requirements to qualify:

  • Creditworthy supplier and customer

  • Profit margins 15 percent or higher

  • Must have business or government customers (B2C not eligible)

  • Must sell tangible goods

Invoice Factoring

This is a loan or advance to tide you over while you await payment of invoices for product or services already delivered. It's best used when you’ve already sold goods or services and are awaiting payment from your customers. Cost is 1.5 percent to 5 percent per month.

Minimum requirements to qualify:

  • Invoices due in 90 days or less

  • Must have business or government customers (B2C not eligible)

  • May sell goods or services

  • Creditworthy customer

Similarities and differences

Many fast-growing businesses come to a point where sales outpace incoming revenues, leaving them without enough cash on hand to cover operating expenses or new orders. PO financing and invoice factoring help small businesses stabilize their cash flows and gain access to working capital.

Funding through either of these methods can be obtained in a matter of days. According to Priyanka Prakash, analyst at Fit Biz Loans, “They are ideal sources of funding for startups or bad credit borrowers because approval is based on the creditworthiness of the end customer, not on the profitability and credit history of the business or business owner.” B2B and business-to-government businesses are eligible to use these types of financing (B2C businesses are ineligible).

In many cases, factoring and PO financing provide access to large amounts of working capital. The size of your credit line depends mainly on the number of purchase orders or invoices that your company is able to generate.

The main difference is when they’re used. Invoice factoring is used after a business sells goods or services. PO financing, available only to businesses that sell tangible goods, is used before selling anything.

Invoice factoring considerations

Are you a trucking company that is waiting to be paid for something you shipped over a month ago? An accountant still waiting to be paid for financial services that you provided last tax season? According to a survey by the National Federation of Independent Businesses, 64 percent of small businesses have unpaid invoices. Invoice factors loan you money to cover operating costs while you await payment on invoices.

Small businesses that offer 30- to 90-day payment terms to their customers may use invoice factoring, also known as invoice financing. Trucking businesses, clothing designers and consulting companies are among the businesses that commonly rely on invoice factors to turn unpaid invoices into cash.

Invoice factoring tends to be cheaper than PO financing because a steady fee is charged every month. In contrast, PO lenders usually increase fees if your customers don’t pay for goods within one month.

In addition, invoice factoring is usually faster than PO financing. It takes about two to three days to get your money if you work with an invoice factor, whereas PO lenders take about one to two weeks to get you your money.

Purchase order financing considerations

Imagine landing a large order from a major business or government client and then not having the resources to fulfill the order. If you can get the means to fulfill the order, that could jumpstart your business’ growth and success. If you can’t, it could stop your growth in its tracks.

You can use PO financing, also known as purchase order funding or purchase order lending, to resolve this problem. The purpose of purchase order financing is to extend you capital that will allow you to fulfill the customer’s order. A lot of small businesses with big business customers, as well as seasonal businesses with irregular spikes in sales, turn to PO financing to fulfill large orders. In order to use PO financing, you must sell a tangible product, not a service.

The purchase order lender will pay your supplier to manufacture and deliver the goods to your customer. Once your customer accepts the goods, the customer pays the purchase order lender directly. The lender then deducts its fees as well as the amount it paid the supplier and pays you the remaining balance.

PO financing is less flexible than invoice factoring. The money can only be used to pay the supplier. In contrast, when you receive an advance of working capital from an invoice factor, the money can be used for any business purpose.

Startups are eligible to use PO financing, but the business owners must have experience (perhaps from a prior job) fulfilling large orders and ideally should have a pre-existing relationship with the supplier. There are many parties involved in a purchase order transaction, so lenders prefer an arrangement that has worked in the past.

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