Purchase Order Financing Or Equity. Which Is Better For The Growth Of My Business?

Purchase Order Financing Or Equity. Which Is Better For The Growth Of My Business?

Purchase Order Financing

Purchase order financing is the most frequently requested business loan inquiry we receive. Depending on the size of the orders and opportunities that lie ahead for the company, bringing in an equity investor is also a consideration. There are distinct advantages to both and we will outline the main advantages of each here.

The day has come! The customer you have been chasing for weeks, months or even years gives you the purchase order that you have been hoping for! Now, how do we afford to pay suppliers and other costs associated with the order? Ideally, you would be able to do this with internal cash flow and not have a need for outside financing. However, the truth is, if you are doing a good job on the sales and marketing side, you will quickly outgrow your internal capacity. AND, this is a good thing! Of all the stresses business owners encounter, having a large pipeline of sales if the best!

The conversation quickly turns to, “how do we afford these orders now that we have them?” Is purchase order financing or equity the better option? The answer, it depends.

Purchase Order Financing

By financing the cost of goods for your orders, you are leveraging the growth of your business through outside capital. Let’s go through an example:

  • You receive a PO for $100,000
  • Your gross profit is 50%
  • This makes your cost of good also 50%
  • You borrow $50,000 to cover the costs to your suppliers, shipping costs, etc.
  • Your working capital cycle is 90 days from the time you receive the order, to the time you ship, to the time the customer pays
  • Cost of the financing is 3% every 30 days the money is outstanding

Let’s say a major retailer awarded your company a $100,000 PO as outlined above. You need to borrow $50,000 for 90 days. The cost of the financing will be $4,500 for the 90-day period ($50,000 X 9%). Your adjusted gross margin would be $45,500 ($50,000 – $4,500).

The purchase order finance company is repaid by the customer’s payment. By using this form of financing you are leveraging 100% of the cost of goods and have the capital to grow your business. Additionally, the PO financing allows you the added strength of being a cash buyer. Our clients negotiate discount terms with suppliers to offset a portion of the cost of the financing.

For example, a 2% product discount for early payment in the sample transaction above would equate to $1,000 ($50,000 x 2% = $1,000). This savings in product cost would reduce the adjusted finance cost to $3,500 ($4,500 – $1,000 = $3,500).

The advantage of purchase order financing is that it can grow as your business grows assuming your customers are credit worthy. The PO finance company’s primary source of repayment is the customer. This makes the customer’s financial strength a key factor in underwriting these transactions.

The disadvantage of PO financing is that it only covers variable expenses associated to sales. This is where equity may be a better fit.

Equity Capital

Equity comes in to play when you need more than your cost of goods covered. Examples of when equity may be a better call would include the following:

  • The equity group brings value outside of the capital being invested such as supplier and customer contacts.
  • In-roads and introductions of value that the equity group brings to the table
  • When funding for marketing, salaries, plant expansion, and other fixed expenses are needed to grow and scale the company

The equity group will take a percent of ownership in exchange for their investment. The strategy may or may not include the sale of the company in the future at some multiple.

Equity can be a viable option if there are a lot of fixed expenses to be covered. Prepare to give away a large chunk of your company when exploring equity options. The equity group is seeking a return on their investment and realize that they are in the power position by bringing in the majority of the capital needed to grow the company.

Summary

Both forms of financing can be useful when growing your business. Purchase order funding can be used as a bridge to finance your growth. Once you scale your business to a certain level and can fund operations internally, you don’t need outside financing and can save the finance cost. On the other hand, equity can cover the costs of a much broader list of expenses. The downside is that it’s a “now and forever” proposition. The equity group and your company are joined “until sale do you part.”

We always advise on debt versus equity when you can. It’s the bridge needed to grow your business, but not permanent by definition. If you would like to discuss which form of financing is best for your business, call us at 844-239-2632. We would be happy to lend a hand!

To your success!

Huntington Coast Capital.

Finance 100% Of Your Purchase Orders!

Finance 100% Of Your Purchase Orders!

May 2022 HCC Email Blast

Purchase Order Financing can cover 100% of your supplier cost!

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Cost of goods is the single biggest expense for a lot of companies. This cost grows as your business gains new customers. Your ability to deliver will keep those customers coming back. Failing to fulfill an order can result in losing a customer forever!

The challenge we see in consulting with our clients is a lack of capital to meet growth needs. Most all purchase order and supply chain finance companies require “skin in the game” from the borrower. This typically translates to the borrower bringing in 20-30% of the cost of goods to fulfill the orders. Depending on how big the order is, this can be challenging. For example, you receive a $500,000 order from a customer that requires a 30% investment contribution from the lender. This equals a $150,000 cash requirement from the borrower to place toward the order. Most all companies we deal with do not have the “equity” for the transaction and this is the very reason they are in search of financing.

What are the key components to receiving 100% financing for your purchase orders? 

  • Strong supplier relations. It is easier when the borrower has a verifiable transaction history of successful delivery with the supplier. The greatest chance of approval is when the finance company is being asked to take the borrower’s current production from “A to B” versus a first time order with a new supplier that has never been used before. There is “execution risk” inherent in this type of financing and the funding source needs to be comfortable with the supplier’s capabilities.
  • Credit worthy customers. It is essential that the customer presenting the purchase order has adequate credit strength relative to the size of the order being placed. For example, a small mom-and-pop shop placing an order for $1,000,000 of any product would have a harder time getting approved than Walmart or Target.
  • Ability to direct customer payments to the lender. Collection of the invoice to the customer needs to be routed through the lender’s bank account. This is the primary source of repayment. Once the customer pays, the lender’s line is paid down, followed by finance fees, with the balance forwarded to the client. This balance represents the client’s profit in the transaction.
  • Direct payment to the supplier. Similar to the lender requiring payment directly from the customer, the lender also needs to pay the supplier direct. Payments to intermediaries, brokers, or anyone aside from the actual supplier is prohibited. The lender needs to ensure that the supplier is paid for the goods they are producing. Payment to any other source leaves the lender at risk.
  • Established borrowing entity. We are occassionally approached with purchase order or supply chain financing requests (sometimes in the millions of dollars) from newly formed entities with no assets and limited, if any, transaction history. These are naturally challenging. The exception would be if this newly formed entity was owned by a solid team of owners with previous experience in the same industry as the newly formed endeavor. Even still, the owners in these scenarios would need to have a strong outside net worth and secondary source(s) of collateral to pledge should the transaction go south and the lender need to be made whole.
  • Personal guarantees required. When there is resistence to personal guarantees, there is resistence from the lender to approve the line of credit. When borrowers request the removal of a personal guarantee they are essentially saying, “we need money to fulfill orders, grow our company and profit from that growth, but we are not willing to promise to pay you back. If you lose your money, too bad.” Well, they don’t actually say it in these terms, but they might as well because that is what the lender is hearing. It is required that the borrower(s) stand behind the proposition they are asking the lender to finance.
Is your business experiencing growth? Since our inception in 2010Huntington Coast Capital has been connecting business owners to flexible growth capital solutions through our nationwide network of capital partners. We can help!

About Huntington Coast Capital. 

Huntington Coast Capital secures funding for companies in a broad base of industries. Our clients come to us to find a more flexible lending partner to meet their growth needs. Many are declined by the bank and are in need of a more creative and entrepreneurial funding solution.

We consult on a wide range of funding options for business owners throughout the United States in the following areas:

  • Supply chain financing 
  • Equipment loans and lease programs (learn more about our equipment loan platform offered through our subsidiary)
  • Lines of credit for working capital needs
  • Term loans for marketing, hiring staff and general expansion needs
  • Factoring services for accounts receivable financing that also provides for back office credit and collection functions
  • Purchase order financing
  • Asset based loans
  • Business acquisition financing
  • Inventory financing
  • Private commercial real estate bridge loans
  • SBA loans for business and real estate needs

Whether you are a startup or established, in need of $100,000 or $10,000,000 we have the capital partners to meet your needs. Contact us to see how we can assist in taking your business to the next level. Purchase Order Financing can cover 100% of your supplier cost!

Patrick Zazueta
Huntington Coast Capital, Inc.
Direct: 714-719-8966
patrick@huntingtoncoastcapital.com
www.huntingtoncoastcapital.comBRE License #: 02090967

Purchase Order Financing Versus Letters Of Credit

Purchase Order Financing Versus Letters Of Credit

Paying suppliers is a required and continuous expense for business owners whether you’re in retail, own a restaurant or are a manufacturer or distributor. Cost of goods sold is the first deduction against gross revenue on any companies income statement. The lack of ability to pay for the cost of goods expense severely impacts the growth potential of the business. In this article, we are going to look at the difference between purchase order financing and letters of credit and how they are used in business.

Letters of Credit

Letters of Credit (abbreviated “LC’s”) are bank instruments drafted to secure international and domestic purchases. They provide assurances for both the buyer and the seller of the goods. The seller is assured payment as long as the terms within the LC are met. These can include satisfactory inspection and acceptance of the goods at the port, factory or upon arrival to their destination. When the goods are paid for under the LC is negotiated between the parties.

Letters of Credit essentially assure two things: 1) the buyer has the financial wherewithal to make the payment for the goods, and 2) the supplier will deliver the goods as ordered on time. LC’s are opened with both the buyer’s bank and the seller’s bank and work together to assure the performance of each.

Requirements are a bit more strict with Letters of Credit than they are with purchase order financing. The LC has to have underlying collateral that is typically in the form of cash or accounts receivable.

When a company applies for a Letter of Credit from a bank the company must have an equal or greater amount of cash or accounts receivable available once the LC is drawn on. The buying entity needs to demonstrate that they have the financial wherewithal to cover the cost of goods once conditions have been met. The buying entities funds are typically held in a control account (similar to an escrow account) until needed. This control of the funds is necessary to assure the supplier that funds will remain available for payment from the time ordered to delivery and payment.

In this respect, LC’s really are not a financing tool as no monies are actually borrowed but rather set aside for a particular transaction. This form of international trade “finance” is a protection against financial loss on available capital versus new money used to cover the cost of goods.

This form of financing is set aside for more established companies with enough liquid collateral available to cover the expense. Consider LC’s as an insurance against loss of principle versus true outside financing. For more granular details on Letters of Credit click here.

Purchase Order Financing

Conversely, purchase order programs offer financing to cover the cost of goods to suppliers beyond cash and accounts receivable collateral. Startups, companies experiencing high growth and even the majority of established companies often need additional capital. In the majority of cases, the capital needs are larger than the accounts receivable balance or internal cash reserves.

In these scenarios, Letters of Credit would fall short of the financing needs required to cover the cost of goods.

Purchase order financing pays suppliers for materials required for the buying entity’s growth. Clients utilizing purchase order financing sign contracts with the finance partner. There is typically a personal guaranty for the facility that acts as a backstop should the transaction not offer enough support to pay back the line in a downside scenario.

Purchase order finance underwriters focus on three main areas when assessing new funding requests:

  • Financial strength of the customer(s) for which the PO’s are being generated: when purchase order financing is being requested the fund will want to thoroughly understand the credit strength of the underlying customer. For example, if the underlying customer is a nationally known retailer odds of approval are greater. Conversely, if the PO’s are being generated for a “mom and pop shop” with limited to no financial information available, approval is much more difficult.

 

  • Financing strength of the supplier: the source of where the goods are coming from whether international or domestic must also be fully understood. Suppliers are typically larger and more established. Usually, but not always, financial information is available on these companies and information can be verified to give the purchase order finance company comfort in wiring them money for the transaction.

 

  • Transaction history between the parties: It is important to know how long the client has been dealing with a particular supplier. Approval is much easier if there is a long history that can be documented through shipping documents, invoices and bank transactions supporting successful delivery of past orders. Purchase order financing works best when taking a company’s current business cycle from Point A to Point B versus financing orders for an entirely new supplier relationship that has zero past transaction history. This is because there are a number of inherent risks that go with financing first time orders; lack of past, successful delivery of orders, fraudulent supplier claims, capital at risk before performance, to name a few.

Purchase order financing is a line of credit used specifically to cover the cost of goods when capital needs are larger than available internal cash or accounts receivable.

In Summary

If you are an established company with no need to borrow outside capital, a Letter of Credit would be adequate for your needs. LC’s provide assurance against loss of principle by providing a check and balance prior to releasing funds.

Purchase order financing comes in to play when cash needs are higher than internal capabilities.

Both mechanisms facilitate trade financing and move business forward. Which program is best for your company depends on where you fall on the spectrum. To learn more about how Huntington Coast Capital’s purchase order financing solutions can work for you, watch this short video that explains the process.

We provide consultation and secure funds for a broad base of business financing needs. Call 714-719-8966 to learn how these programs can work with you to grow your business!

What Is The Cost Of Purchase Order Financing?

What Is The Cost Of Purchase Order Financing?

Purchase Order Financing

A common question we receive is, “what is the cost of purchase order financing?” Purchase order financing has been widely used to assist distributors, wholesalers, manufacturers and retailers in growing their business. Purchase order financing specifically covers the cost of goods required from suppliers. Examples are numerous but for example, if you own a spice business, you would need to pay suppliers that harvest and manufacture the spices along with the bottlers and shipping companies to get the finished product to your end customer.

Most businesses can self-fund the cost of their company’s capital needs internally when first starting out. However, if they are successful in their marketing efforts, they will eventually experience orders that outstrip their available cash flow. The goal of any company is to grow and become well-known in their space. More often than not, financing is required to make this happen.

What is the Cost of Purchase Order Financing?

In short, the cost of purchase order financing ranges from 2-3% for every 30-day period the loan remains outstanding. Some PO finance companies will cover 100% of the cost of goods including shipping costs and some will require a 20-30% cash contribution from the client company.

How do I know if the cost of purchase order financing is something I can afford without giving away all my profit? 

The analysis required in assessing whether purchase order financing is right for you is different than the loans most people are used to applying for and have past experience with. Most of us have applied for or have a mortgage and/or an auto loan. These types of loans are largely commodity based financing whereby 100% of the focus is on the annual interest rate and monthly payment. These are the most widely used forms of installment loans.

Purchase order financing is a much different analysis. In reviewing this form of financing, we are looking at the opportunity cost of taking on outside financing to fund the growth of our business. We want to maintain our margins as much as we can while growing the business and scaling our products or services.

How to measure the cost of purchase order financing.

To keep the math simple, let’s say your company’s product has a 30% gross margin. You receive an order from a big customer that you have been pursuing for many months and the hard work has finally paid off with a sizeable order!

You need to pay your supplier $100,000 for which you will receive $130,000 from the customer once delivered. The total time from the customer order to receipt of the product is 60 days. The cost of the purchase order financing is 3% per 30 days.

A breakdown of the transaction would be as follows:

  • $100,000 borrowed
  • 6% effective cost for 60 days (3% every 30 days)
  • $6,000 total financing cost ($100,000 multiplied by .06)
  • Customer pays $130,000 for the product
  • Total gross profit is $24,000 ($130,000 minus $106,000 which is the money borrower plus the fee for the capital)

The $24,000 profit would not be realized without financing the cost of the order. You are leveraging the cost 100% and earning profit with “other people’s money” as they say. This ratio would be the same whether there was just $10,000 or $1,000,000 borrowed.

So the question isn’t “what is the interest rate” but rather an opportunity cost analysis. Would you spend $6,000 to earn $24,000? Similarly, would you spend $600 to make $2,400 or $60,000 to make $240,000? Of course you would!

How does my company qualify for purchase order financing? 

There are a couple of points the credit manager will consider before issuing an approval on a purchase order financing facility. In summary the areas of focus are:

  • The financial strength of the customer placing the order (i.e. if they are the requesting $130,000 worth of product be delivered before payment, are they financially strong enough to warrant the credit risk?).
  • The financial strength of your company as the borrower (can your company survive a delay in payment or complete loss on the order? Are there other customers you can sell the same product to in an emergency situation such as an order cancellation?)
  • Past track record of successful delivery to the customers and verification of the supplier efficiency in fulfilling the orders correctly with minimal disputes.
  • Your company’s time in business. While is not impossible to receive PO financing on your company’s very first orders, both the customers financial strength and your company’s starting capital would need to be strong.

These are just the four initial considerations underwriters take when reviewing a purchase order financing requests. Variables exist depending on the industry your company is in, typical payment terms in your industry, where your suppliers are located, among others.

How do I apply for purchase order financing? 

If your company could benefit from this form of financing, we would like to speak with you. You can reach us at 844-239-2632. A brief 5-10 minute phone consultation can determine whether or not purchase order financing is a good fit for your business.