How to close the cash flow gap between getting a purchase order and invoicing against it

“The PO came through!”

The news quickly spreads through the office that a legally-binding commitment from a buyer to pay for your products or services has arrived. It’s a big deal. Sales teams can wait weeks or even months for a large purchase order (PO) to be issued before they can finally celebrate a deal.

But, while it’s great news when your business gets a large PO, not every company has the liquid cash needed to fill every order — particularly when multiple orders are on the table. This could mean a cash flow problem.

The problem with purchase orders

The delay between receiving a PO and invoicing against it is problematic for many small businesses. Most POs include an agreed-upon invoicing date. Once the order is filled, your business can issue an invoice against it. However, you may need to wait days or weeks before you get paid. And for some businesses, it can take even longer, leaving little wiggle room in terms of cash reserves. This makes it harder to purchase the inventory, equipment, and staffing needed to fulfill each PO.

Faced with this predicament, many businesses consider turning to traditional banking institutions for a loan. But banks are lending fewer and fewer dollars to small business owners. And major banks tend to only approve loans for businesses with high credit scores or those that have been in business for a long time.

Even a traditional business line of credit can be difficult to obtain. Banks require substantial amounts of documentation to support the application, including financials, personal and business tax returns, incorporation and registration information, etc. A credit line may also have fees attached to open and maintain it.

What about purchase order financing?

A little-known alternative to these funding options is purchase order financing. Purchase order or “PO” financing is an arrangement where a third party agrees to give you, the supplier, enough money to fund a customer’s purchase order in part or in its entirety. When you’re ready to ship the order, the purchase order financing company collects payment directly from your customer. After subtracting their fees, the company then sends the balance of the invoice to your business.

While it can take a lot of time to secure a loan from a traditional financial institution — assuming you’re lucky enough to qualify — PO loans are typically easier to obtain since these lenders are more interested in the creditworthiness of the customers that send in purchase orders. This is especially beneficial to newer companies that might have a large purchase order sprung on them when they’re not ready for it.

Because it’s not a loan, you won’t have to make monthly installments to repay the debt. Once you’ve established a relationship with a PO financing company, the money can be quick and relatively easy to secure when you need it.

The downsides of purchase order financing

But PO financing does have its downsides. You can expect the lender to take a sizeable percentage of the entire PO once they’ve been paid by the customer (between 1.8% and 6% each month), which can affect your profitability. And, because the lender essentially acts as a collection agency and interacts with your customer directly (just like invoice factoring) they may become aware of your cash flow challenges — and you might not want your customers or clients knowing your financial business.

If you’re using PO financing, some customers may think that your business is in trouble and be more hesitant to work with you. They will also likely be confused about why a third-party company is contacting them about a payment owed to your business. You can preempt this impression by giving the customer advance notice of what’s going on, but it still may lead to a difficult and time-consuming conversation.

Another thing to consider is that PO financing companies only work with businesses that sell physical products that they do not directly customize or manufacture. Service-based businesses must look elsewhere for financing options, some of which we’ll cover below. PO financing also only covers the cost of orders, so if you’re looking for an injection of cash to grow your business, you’ll need to find another solution.

Other ways to bridge the PO to invoicing cash flow gap

Given the downsides and limitations, purchase order financing may not be the best fit for your needs. If that’s the case, there are many solid alternatives to bridge the cash flow gap between receiving a purchase order and invoicing against it.

Consider these six alternative sources of capital:

• Invoice financing: Not to be confused with invoice factoring, invoice financing lets you borrow against an unpaid invoice. If you need cash to fund a PO, you can choose which invoices you want an advance payment on (up to your approved credit limit). Depending on which financing firm you work with, you may only get a percentage of your invoice value, which may not be enough to fund your PO. However, repayment schedules and fee structures may vary – with Fundbox, for example, you can get 100 percent of your invoice value, and funds can be made available as fast as the next business day.
• Merchant cash advances (MCAs): Qualifying businesses who process a lot of credit card transactions each month can get these cash advances in exchange for a fixed percentage of future credit card receipts. While MCAs are typically easier to get than more traditional loans, many business owners find it tough to keep up with the frequent repayment schedules. Many MCAs also have several types of fees attached, which can drive the APR into the triple digits, so make sure to read your agreement and understand all the fees before you sign.
• Traditional term loans: As mentioned above, while these used to be the go-to option for small business financing, as they tend to have some of the best rates, fewer banks are funding small businesses. The application and the time to getting funded can also be a barrier to business owners seeking funds in a hurry.
• Loans from non-bank lenders: Relatively new to the funding market, these alternatives have opened the doors to small business loans for borrowers who may not qualify for a traditional bank loan. However, look out for potentially high interest rates and repayment demands should your business fail.
• Outside investors: If you’re looking for more than just funds, an outside investor might be the best choice. The right investor can help steer your business on its growth path. You just have to be willing to give up equity and, often, some control of your operations.
• Business lines of credit: A line of credit is a pre-agreed-upon amount of money that you can borrow when you need it and repay back when you don’t. Unlike a loan, the money can be used as and when you need it for things such as one-time purchases or expenses. You have some flexibility about when and how to repay your credit line, unlike a bank loan which has a fixed monthly repayment schedule.

Growing your business means making tough decisions about funding that growth. With a wealth of options available, cash flow problems shouldn’t get in the way of filling purchase orders, large or small. Learn more about purchase order financing options and put the skip back in your step when the next PO lands on your desk.

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