In the prior scenarios, the goods were handled in each case by third parties. In this case, the goods come in to the client’s own warehouse where they have to be picked, packed and shipped by the client to fulfill the order. Although the goods are finished, we now have to evaluate the history and ability of the client to perform. Although the process may be simple, the client must not only have the capacity to fulfill the order but also have verifiable cash flow from other sources than purchase order financing to cover overhead to fulfill the order. If these facts don’t exist, an alternative may be a requirement that the client use a third party warehouse to fulfill the order.

In this case, the process entails different items; each item on its own is essentially a finished good but assembled by a domestic third party fulfillment warehouse into a final product for delivery to the company’s customer.

As with goods drop shipped directly to the company’s customer, the risk is transferred to a third party entity in the handling of the goods in fulfilling the order to the company’s customer. However, risk parameters increase due to funds being employed by the purchase order financing to suppliers, either foreign or domestic, for goods to then be delivered to the fulfillment warehouse for final assembly of the finished good. Although this does not eliminate an early stage or a startup company, some history of the company of utilizing the suppliers and fulfillment warehouse will obviously offset a considerable amount of the risk. Regardless, the suppliers and fulfillment warehouse will be vetted out in the due diligence process confirming their ability to perform.

The UCC1 Financing Statement form contains three main sections: debtor information,
secured party information and collateral description. What follows is a brief discussion of
each of these sections:

Debtor Information
Sections 1 and 2 on the form are designated for listing the debtor or debtors by name and
address. A debtor can be an individual person or a business entity. Multiple debtors may
be included on a single filing with up to two showing on the face page of the form and
additional debtors being shown on an additional party addendum form.

In order for a UCC filing to be effective, it must reflect the exact legal name of the debtor.
For business debtors, additional information such as type of organization, jurisdiction of
organization and organization ID may be required..

Secured Party Information
Section 3 of the UCC Financing Statement form is used to identify the secured party’s name
and address. The secured party is the lender or creditor to whom the debtor has pledged
the collateral.

Collateral Information
Section 4 is where the secured party details what items the debtor has promised in order
to secure the loan. The collateral description must reasonably identify the collateral that
is described in the signed security agreement. A UCC filer can list the collateral in box 4 of
the UCC Financing Statement form or on attachment or exhibit pages.

In this example of purchase order financing, the goods are produced, packaged and ready for delivery to the company’s customer by the factory/supplier overseas. The order is completely fulfilled by the overseas supplier. The goods are paid for by purchase order financing and all that remains is the delivery of the product to the company’s customer.

In this case, the prospect could even be an early stage company or even a start-up with a good story. The purchase order lender’s reliance is on the finished goods being drop shipped directly to the company’s customer that mitigates the risk of the company touching the goods and any reliance on the company’s ability to perform in physically handling the goods. The risk is essentially transferred from the company to the factory producing the goods and third party logistics for handling the goods and/or staged at a third party warehouse for delivery to the company’s customer.

Companies facing a cash-flow squeeze and slow-paying customers often sell their invoices or accounts receivable to specialized companies called factors. The factor advances most of the invoice amount – usually 70% to 90% – after checking out the credit-worthiness of the billed customer. When the bill is paid, the factor remits the balance, minus a transaction (or factoring) fee.

Companies that use factoring like it because they get money quickly rather than waiting the usual 30 or 60 days for payment. After sending an invoice to a factoring firm, a business can have money in its hands within 24 to 48 hours.

Some businesses use factoring to get started. Whereas banks focus on a business’s creditworthiness in considering whether to make a loan, factors look at the financial soundness of a business’s customers. As a result, firms with scant credit history may be able to sell their invoices.

Billions of dollars in accounts receivable flow through factors each year, many of whom specialize in particular industries such as trucking, construction or health care. Some companies use it to meet cash-flow needs as a stop-gap measure. Others prefer factoring to banks, which often require more paperwork, or other outside investors, who may want a piece of the business.

Since the factoring firm can handle collections, the factor customer can outsource the billing and credit checking functions to the factor. Another advantage: Companies wanting to expand overseas may find factors often already have extensive experience dealing with overseas suppliers or purchasers and so using factors can make international business efforts a lot easier.

The risk is transferred away from the company to the contract manufacturer. The emphasis is then put upon the contract manufacturer’s ability to perform. Acceptable risk is always a contract manufacturer that has significant experience in the business of producing this product and sustain due diligence with references. In most cases, the contract manufacturer will require a deposit or assurance to get paid to begin production or payment to release goods. Since it’s a domestic contract manufacturer and verified through due diligence the ability to perform, this is a viable transaction even if the client is an early stage company or early stage company.

History with sales and use of the contract manufacturer is not a requirement but certainly helpful in evaluating the risk.

Known as production finance or work in process financing, a product is being produced by the company and shipped to the company’s customer. Since purchase order financing provides only direct costs in fulfilling the order, the company must have a proven history of not only producing the product but also the capacity and the cash flow to cover other non-direct costs. Purchase order financing can include the cost of materials, parts and direct labor to fulfill the order.

The company must be profitable or at least cash flow neutral. The basic concept in mitigating the significant risk associated with production finance is that the order being financed is incremental sales to the company. In most cases, the company has maxed out their line or ability to fulfill the order under their borrowing capacity from their current financing source.

In addition, two main items must also be addressed in the initial assessment of the potential for purchase order financing on a production deal: (1) the number of suppliers required to fulfill the order; and (2) the time involved with the production cycle.

The greater the number of suppliers means more work required in due diligence in vetting out the   suppliers and ability to control the collateral of raw materials and parts delivered to the company. The fewer the suppliers, the more likely that production is of a low tech nature. The more suppliers, the more involved the production process and more risk associated with the transaction. Ideally the production cycle is in days or weeks and the client can invoice as product is produced and shipped, especially on larger orders. If the production cycle is much more than 60 days, the cost of purchase order financing to the company and the risk with the longer exposure of employed funds by the purchase order finance company, the transaction may not make economic sense for either party.

Factoring and purchase order financing are great solutions for today’s fast growing company.  Done right, a company can finance the entire sales transaction – start to finish.

Let’s start at the beginning, the prospect must have a firm order from a customer that meets the credit standards of the factor. The factor also sets the parameters for the amount of purchase order financing based on not only the advance rate established by the factor but also the credit limit to the client’s customer. Essentially the amount of purchase order financing is contingent upon the acceptable credit risk established by the factor so that the factor can take out the amount financed by the purchase order financing, plus fees. That relationship will be established through an intercreditor agreement between the factor and the purchase order finance company.

Purchase order financing steps out beyond traditional collateral. The collateral associated with purchase order financing is the goods, materials, parts, etc. that the client needs in order to fulfill the order. In the world of purchase order financing, the order is fulfilled when it is invoiced, and as a result, creating traditional collateral for the factor.

A key element in evaluating the risk is the client’s gross margin.  The larger the margin the less risk perceived by the lender. A higher margin makes it easier to find another buyer if the purchase order is cancelled by the client’s customer and the higher probability of the funds employed by purchase order financing getting repaid. In addition, another key element in risk assessment is the more specialized the product is to the client’s customer, the more risk associated with finding another buyer.

Later we will explore the different types of purchase order financing.

Well, if factoring your invoices is still not getting you the working capital you need you may need to look for more creative ways to generate working capital. One such way is purchase order (“PO”) financing.  PO lenders are asset based lenders just like factors and banks but PO lenders advance on purchase orders not invoices or receivables.

Purchase order financing is a great solution for when the suppliers and vendors want you to pay upfront for cost of goods but you cannot get an advance from your factor until the goods are delivered and the invoice is valid.  This is a common cash flow problem for manufacturing companies especially because the invoices will not be valid until the goods are delivered at the destination point.

The steps to being ready for purchase order financing are really quite simple. First you need to get a purchase order from your customer, second you need to find a reliable supplier for your products, and place the order with that supplier. Last, you need to have a factor that will advance against the invoice and pay off the PO lender.  Factors and PO lenders can work together to make sure you have the capital you need to grow your company!