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Have you ever received a large purchase order but didn’t have the inventory or cash flow to fulfil it?
Unaware of the funding options available, you may have considered to reject the order, causing you to:
- Lose potential revenue
- Overlook an easy way to improve cash flow
- Disappoint your customers and lose them to competitors
Understanding what purchase order funding is all about as well as what other options are available to you can help you prevent this situation. With PO funding, you can continue to fulfil large orders, earn revenue, improve your cash flow and retain your customers.
In this guide, we will explain all you need to know about purchase order funding and how you can use it to your benefit.
What is purchase order funding?
Purchase order funding (also known as tender finance) is an arrangement where a third-party financing company provides the funds you need to pay your suppliers for the goods you need to fulfil customers’ orders.
Instead of passing on a large customer order you cannot fulfil due to low inventory or cash flow, the purchase order financing company will pay a portion (or all) of the cost for fulfilling that order.
The financing company will receive payment for the order directly from the customer, deduct its fees (typically 4%-6% of the revenue), and then send the remainder to you.
The portion of the cost the financing company will pay will depend on your track record, the creditworthiness of the customer, and the reliability of your supplier. It is not unusual for some financing companies to pay 100% of the cost of fulfilling the order.
Additionally, a simpler and faster solution to traditional purchase order funding is Lula’s Revolving Capital Facility, which can also be used to fill the gaps in your cash flow.
Who needs purchase order funding?
If your business meets any of these conditions, you should consider purchase order funding:
Low cash flow
Purchase order funding is an important lifeline if your business is struggling with low cash flow, a situation that affects 47% of small business owners in South Africa, according to GQ South Africa.
Operating in a seasonal industry
If your business also operates in a seasonal industry where orders can be very low and then very high, purchase order funding is a good way to manage periods of high customer orders, securing your revenue and retaining your customers.
Wholesaler, reseller or distributor
Purchase order financing is typically designed for and used by wholesalers, resellers and distributors rather than producers. If your business depends on buying from producers (or wholesalers) and reselling to retailers (or customers), purchase order funding will be very useful for you.
Difficulty obtaining traditional bank loans
Only 25% of the total financing used by South African SMEs (small and medium enterprises) was supplied by traditional banks in 2020, according to the South African Reserve Bank. If you find traditional bank loans stringent (inaccessible), time-consuming and inefficient, purchase order funding in South Africa can be a better alternative.
How can purchase order funding help your business?
Working capital solutions like purchase order financing can help steady your business in difficult times.
“Accessing the right working capital could help you to take control of cash flow and give you the confidence to take on opportunities when they arise,” says Colin Timmis, country manager of Xero, an accounting software company, in an interview with GQ South Africa.
In particular, purchase order funding can help your business in these ways:
Increase revenue and profit
Purchase order funding helps you secure revenue you would otherwise have lost. Since the fee is usually only 4-6%, you can still make a profit.
Improve cash flow
Increasing revenue is one of the ways to improve cash flow. By helping you secure revenue, purchase order funding can thus also improve your cash flow.
Retain customers
Only 1 out of 26 unhappy customers complain, the rest just churn (leave), according to Esteban Kolsky, CEO of thinkJar, a customer experience company. Leaving customer orders unfulfilled means you are sending them to other brands.
If those other brands make them happy, the chance of them coming back is very low. Purchase order funding helps to avoid such situations.
How does purchase order funding work?
There are four parties to a typical purchase order funding transaction: the customer, your business, the supplier, and the PO funding company (the lender or funder).
Below are the typical steps it takes to complete a transaction:
- Customer sends a purchase order: The process begins with a customer sending an order you can’t fulfil.
- Reach out to a purchase order funding company: If it is your first time, you will need to evaluate and choose a financing company and if you have done this before, you only need to reach out to the one you have used. The financing company will evaluate your application and then approve or decline it.
- The financing company pays the supplier: If your application is successful, the purchase order financing company will pay the supplier a portion (or all) of the cost of satisfying the customer’s order.
- The supplier delivers the goods: After receiving payment, the supplier delivers the goods to the customer to fulfil the order.
- You send an invoice to the customer: Once the customer confirms receipt, you will send an invoice for the goods delivered. You will also send a copy of the invoice to the financing company.
- The customer pays the financing company: The financing company will receive full payment for the goods.
- The financing company sends you the balance: The purchase order funding company deducts its financing fees from the amount received and sends the balance to you.
What is the cost of using purchase order funding?
The financing fee for a purchase order funding transaction is usually a fixed fee for 30 days. For example, if you get R100,000 at a 5% fee, you will pay R5,000.
But that is only if the customer pays within 30 days (reflecting the short-term nature of this arrangement). If payment extends to a second month, the fee will be R10,000, and so on.
Some will use a tiered system where the fee reduces after the first 30 days. For example, the structure can be 5% for the first 30 days and then 2% for every extra 15 days. If the customer pays 37 days later, you will only pay R7,000 instead of R10,000.
The fixed nature of these fees means you will know upfront how much you should expect once the customer pays.
What are the pros and cons of purchase order funding?
If you are considering purchase order funding, then you should be familiar with its pros and cons. Below are the most important ones:
Pros of purchase order funding
Easier to qualify for
Though purchase order funding companies also have requirements, they are not as stringent as traditional banks. For example, if the customer who ordered is credit-worthy and the supplier is dependable, they may be willing to finance the transaction even if you have a poor credit score at the moment.
Start-ups can access funding
Some lenders will even consider providing finance for new businesses (startups) provided the customer is creditworthy and the supplier is well established.
Does not require monthly repayments like traditional loans
Unlike traditional business loans that require monthly repayments, a purchase order funding transaction can be completed in days, depending on the customer.
Quicker to access
The first application might take time (even though it will still take far less time than seeking funds from a traditional bank), but everything is quicker after that.
Outsourcing revenue collection
Since customers pay financing companies directly, they have taken the burden of revenue collection from your hands.
Cons of purchase order funding
A lot depends on the customers
Accessing the fund depends on the creditworthiness of your customers. Also, the fee you end up paying is out of your control since it depends on how soon customers can pay.
Might be inaccessible for service providers
Some purchase order funding companies will only provide funding for the supply of goods, neglecting service providers.
Smaller contracts might not qualify
Most financing companies will also have a minimum size of order they can finance. Anything below that will be out of consideration, a sad fact for some small-scale companies whose ‘large’ orders might still not qualify.
Customers might be uncomfortable with it
Some customers will interpret this arrangement as evidence that your business is facing some troubles. This might lead them to move to another business.
Can be expensive
If the customer delays payment beyond 30 days, fees will be higher and the deal will be more expensive.
What are the requirements for accessing purchase order funding in South Africa?
What you'll need
In terms of documentation, the purchase order funding company will typically require the following:
- A copy of the customer’s purchase order
- A copy of the purchase order you sent to the supplier
- A copy of the supplier’s invoice
- A copy of the invoice you sent to the customer
- Your financial statements and credit report
- Other business information
Beyond documents, the financing company might also require that the value of the order or the profit margin on the sale must meet a minimum threshold. It is common for some to require a gross profit margin of 20% on the order before they can provide funding.
The application processing will also include an evaluation of the creditworthiness of the customer, the reliability of the supplier, your track record, and the trading history between you, the customer, and the supplier.
Finally, some funders will require that your customers are business-to-business (B2B) or business-to-government organisations rather than consumers.
Are there alternatives to purchase order funding?
Though purchase order financing provides many benefits, it is not the only option to explore when you can’t fulfil a customer’s order. Other funding solutions include:
- Revolving capital facility: A revolving capital facility provides you with a certain amount of funds that you can borrow, repay and then borrow again and again. It is a very flexible funding scheme that can be especially valuable for businesses in seasonal industries (unstable cash flow).
- Capital advance: A capital advance is a lump sum fixed-fee funding that can be repaid in instalments over several months. It is useful for meeting emergency cash flow shortages for businesses with otherwise stable cash flow.
- Merchant cash advance: Businesses that receive a lot of money from credit card transactions can get advance cash that will be repaid as a fixed percentage of future credit card receipts.
- Business credit cards: Businesses can also get credit cards that they can use anytime there is a cash flow shortage. It is also a useful business funding solution for businesses in seasonal industries.
- Invoice finance: Companies can use invoice finance to borrow cash against outstanding liabilities. They can use these funds to fulfil new customer orders and repay them with a fee when the new customer pays. Its advantage is that customers pay directly to the company so they don’t have to know what the company’s cash flow situation is.
- Invoice factoring: Here, outstanding invoices are sold outrightly for cash. The financing company will deduct a percentage of the invoice amount as fees and pay out the remainder to the borrower. When the customer is ready to pay, the money goes to the financing company.
- Inventory finance: Inventory finance allows you to borrow money to purchase inventories with those inventories serving as collateral. Once the inventories have been sold, the financier can be repaid with a fee. Businesses can use this to fulfil new customer orders and then repay when the invoice is paid.
How can you access purchase order funding in South Africa?
Is your business facing cash flow challenges or do you operate in a seasonal industry where orders vary?
This should not force you to pass over customer orders that you can’t fulfil. Traditional South African banks may be slow and stringent, but that should not make you lose revenue, profit, customers and cash flow.
At Lula, an SME funding provider, we aim to ensure that your business thrives irrespective of current cash flow challenges and the industry where you operate. We do this by providing financing options that are well-adapted to your unique situation.
If you need PO funding, Lula has a suitable alternative solution for you. Lula’s Revolving Capital Facility provides businesses with flexible, on-demand access to cash to ensure your business can continue operating in challenging circumstances.
To qualify, you need to be:
A South African business
Established for at least a year
Generating a minimum of R500,000 in annual turnover
We ensure that we provide you with:
You can easily open an account to apply for Lula’s Revolving Capital Facility and link your bank account for quick assessment. We’ll conduct a real-time evaluation of your business without requiring any paperwork during the application process.
You can complete your application in a few minutes and receive funds into your account within 24 hours after we have accepted your application.
We’ll ensure you get access to funds without surprise fees that can harm your business. Repay over an agreed term, with fixed costs that won’t change.
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