Education Library · Financing Tools · Article 6
A commercial customer sends you the biggest order you’ve ever had, and you’d have to pay your supplier for all of it before the customer pays you anything. That’s the situation purchase order financing gets pitched for. It’s a narrow tool, and it fits fewer trades businesses than most owners expect.
What PO financing is
A purchase order, or PO, is a customer’s written commitment to buy specific goods from you at an agreed price. PO financing uses that commitment to pay your supplier so the order can be filled.
In a typical deal, your customer sends you a PO and you get a quote from your supplier. The PO financing company reviews the order, your customer and your supplier, and if it approves, it pays the supplier directly, often through a letter of credit. The supplier ships to your customer, you invoice the customer, and in many deals the customer pays the financing company or the invoice gets factored to pay it off. The financing company takes its fees and sends you what’s left. The money usually never touches your account.
It pays for goods, not labor
PO financing is built for buying finished goods that get delivered to a customer. It generally doesn’t pay for labor, installation or the cost of running crews. That’s why it fits resellers, distributors, wholesalers and importers, who buy a product and deliver it without changing it much.
Most home service and trades businesses don’t work that way. An HVAC contractor installing a system is selling labor and expertise as much as equipment, and a plumbing company on a new construction job bills for work done in stages. PO financing won’t cover the crew, the permits or the time on site. It may cover the equipment portion in some cases, but many funders won’t take a deal where installation is part of what the customer is paying for.
What PO funders look at
Approval leans less on your credit and more on the deal: whether your customer is a creditworthy business or government agency, whether your supplier is reliable and can deliver as specified, whether the gross margin on the order is healthy (often 20% or more, so there’s room for the fees and a profit for you), whether the order meets the funder’s minimum size, and whether you’ve filled orders like this before.
What it costs
PO financing is one of the more expensive kinds of business financing. Fees are often charged as a percentage per month, commonly a few percent for every 30 days the money is out. When the order takes a while to ship and the customer takes a while to pay, those fees stack up. On a thin margin, the deal can end up making money for the funder and very little for you, so run the numbers from the day the supplier gets paid to the day your customer pays the invoice.
When it makes sense and when it doesn’t
PO financing can work when you resell or distribute physical goods, you have a confirmed order from a creditworthy commercial or government customer, the margin can absorb the fees, and the order is bigger than your cash or credit can handle on its own. It’s generally meant for an occasional spike, not for how the business normally runs.
It’s usually the wrong tool when most of what you’re selling is labor or installation, when your customer is a homeowner, when the margin is thin, or when the real problem is ongoing cash shortfalls rather than one specific order.
Other options for contractors
If you’re a contractor facing a big job that requires buying a lot of materials or equipment up front, there are usually better places to start. Many supply houses and distributors offer net 30 or longer terms to established accounts, and building those relationships ahead of time is one of the cheapest ways to handle material costs. Collecting a deposit and billing in stages on commercial contracts can cover a lot of the up-front cost. A business line of credit set up before you need it can cover materials and labor at a much lower cost.
For service businesses with big commercial customers, invoice factoring or AR financing is often the better match. An electrical contractor we work with had a large food processing customer sending multiple purchase orders, with a year-long project of roughly $2.6 million on the table. On the surface it looked like a purchase order question, but the work was mostly labor billed as it was completed, so the conversation was about factoring the invoices once they went out to a customer with a strong payment record.
This article is educational and isn’t legal, tax, accounting or lending advice. Program rules, lender terms and credit bureau practices change, so verify current terms before acting.
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