One of the ironies in business is that if you want to increase revenue, sometimes you need to borrow money. The reason is simple: growth is expensive. Suppliers will almost always require payment before you have received money from sales.
Managing cash flow is the toughest job in any firm. The cautious firm that relies on income to fund expansion rather than borrowings will limit the maximum speed of growth, as income will always lag behind expenses. In most firms, particularly in manufacturing, the only way to increase income substantially is to increase outgoings – on materials, manufacturing, transport and other costs of sale.
But where does a firm get the credit to tide over the delay between paying for goods to be made and sold, and receiving the income from them?
Unfortunately, credit has remained difficult to come by since the global financial crisis. Many of the traditional avenues for obtaining credit, such as bank or private loans, have become too restrictive or expensive. One alternative is purchase-order financing, where a lender steps in to cover the cost of manufacturing and takes a percentage directly from sales.
The advantage for a small firm is that it can take orders much larger than it could otherwise afford. A supermarket chain could order 100,000 units of hand soap from a boutique supplier. The purchase-order lender evaluates only the credit history of the buyer, in this case the supermarket chain.
If the chain shows that it pays its bills on time, the lender pays the soap manufacturer directly. The soap is shipped straight from the factory to the supermarket chain and payment is received by the purchase-order lender, which passes on the margin to the boutique supplier.
Advantages
} A firm with cash flow problems can gain easy access to money based on the financial reputation of a large client.
} The loan is effectively debt-free and avoids the time involved in applying for a bank loan, and the possibility of rejection.
} A firm never has to turn down an order because it doesn’t have enough money to cover operating costs.
} The purchase-order lender takes care of collection.
Disadvantages
} Purchase-order lenders can charge high fees for the convenient access to credit.
} If the client insists on payment terms of 60 or 90 days, a second lender may be required to pay the purchase-order lender upfront.
So it’s worth considering other finance options before considering a purchase-order loan. But in the absence of a viable alternative, a purchase-order loan can be the difference between accepting a large order and turning it down.
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