Many business owners get confused about the differences between purchase order funding and accounts receivable factoring. Although the type of funding is somewhat the same in that funds are advanced to the company relating to products or services sold to customers, there are important differences.
Invoice factoring is the result of products sold or services performed that have been satisfactorily accepted by the customer. Once the invoice is generated, the factoring company advances a contractually agreed upon percentage of the invoice total. Therefore, the credit risk for the advance is based upon the creditworthiness of the business customer.
Purchase order financing involves a situation in which the company needs raw materials or components to produce the product, but lacks the capital to purchase them outright. Once the P.O. has been verified, a letter of credit will be issued to the supplier which guarantees that they will be paid upon shipment of the order. When the order is delivered the P.O. funders’ letter of credit must be paid off. The LC only secures the shipment from the supplier. Since it does not provide the capital advance necessary to pay off the PO finance company, many companies use invoice factoring in conjunction with P.O. financing so that the order goes through without interruption. Since the risk of PO funding is based upon the reliability of the company to both produce and sell the product, rates tend to be more expensive than factoring.
Kent Harlan, CPA
Ozarks Capital Funding, LLC
417.849.7394
www.ocflink.com
kenth@ocflink.com
January 19, 2008
Purchase Order Funding vs. Invoice Factoring
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3 comments:
Using receivables factoring for obtaining extra funding for your business is a great idea. Mostly because, when they consider the loan amount to give you, they only give you what they know you are going to be able to pay back, based on what your customers owe you. It's really a win-win situation; your finances have been heavily considered so you don't have to worry about being in over your head and not being able to repay the financing. Also, they are very easy to get approved for!
It s very useful when we use Purchase Order Funding because we can pay our supplier in advance of shipping the product if that is what they require with purchase order funding. Advance payments can be made to them or a Letter of Credit supporting the payment obligation can be made.
Purchase order financing is a tremendous help to business owners who understand the subtle nuances between it and invoice factoring. Thanks for taking time to explain the differences between the two forms of financing.
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