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South Sheridan Executive Centre
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PURCHASE ORDER FINANCING IN CANADA
Purchase Order Financing, and inventory financing are relatively new alternative financing solutions in the Canadian business environment. These two solutions provide additional flexibility when combined with tour Canadian chartered bank or independent finance firm's traditional financing sources. Let’s dig in.
Traditional business financing in working capital and cash flow revolves found the traditional current receivables and inventory assets. Even if your firm is well financed and has a traditional bank line of operating credit, you may face large orders and contracts. This challenge becomes equally daunting when you don’t have traditional financing, so the ability to generate cash to fulfill larger orders and contracts becomes seemingly impossible.
Purchase order financing can provide you with the capital to fill those large orders and contracts, and, if properly put in place; can be very complimentary to your current financing.
As we have noted the concept of purchase order financing, aka ‘P.O. Financing ‘is a relatively speaking, new phenomenon in Canada.
So how does it work? Simply speaking financing is put in place to cover your material costs and direct labor costs, which are of course a significant part of your order or contract. We can safely say in many businesses that is 60-70% of the total order or contract based on most gross margins in any industry.
Your firm therefore has the working capital to finance your production .What’s left, of course, is essentially the profit on your P.O. or contract.
While it sounds relatively simple and easy ,we would point out some key critical issues that will allow the Canadian business owner and financial manager to determine if their firm qualifies for such financing. We can first of all say there has to be sufficient proof that your purchase order or contract is with a valid, creditworthy party. Naturally, if there is any doubt that your order might not get paid or that the customer is not creditworthy, that precludes successful completion of any purchase order financing.
You should also not view the purchase order financing as a long term financing solution, it is not that. The funds are generally repaid immediately when you have completed your order / contract.
PURCHASE ORDER FINANCING VS. FACTORING
There are also some technical issues that need to be addressed if you have secured financing arrangements in place already. For example, if your firm has a bank line of credit they would be required to acknowledge the security that is taken in the Purchase order and resulting receivables that you create out of that order.
In our own experience Purchase order financing frankly works best when there is not a secured lender in place already, but that’s just our firm’s observation. Additionally, on occasion, certain other collateral or personal guarantees might be required. We would hasten to add that if you have already provided guarantees to the bank or other firms, it would seem logical that you would provide them on the purchase order financing, which is somewhat of a riskier transaction for the lender.
Another very critical point is the whole issue of gross margin. The issues are that you need good gross margins to complete purchase order financing! A firm that a low margin, very commodity-oriented business is not a strong candidate for P.O. Financing because the combination of cost of goods, labor, overhead costs, and financing costs of the financing leleavesery little for the business owner . So categorically good gross margins make a much better P.O. Financing deal.
So why has this type of financing become popular – that’s fairly easy to understand. First of all the current Canadian business financing environment is challenging – therefore any alternative financing vehicle has a strong chance of being embraced and becoming more popular . After that, it simply makes sense that p.o. financing can be very successful for your firm if it gives your company working capital you didn’t have; it allows you to grow and profit at greater levels d proves your competitive positioning within your industry .
We strongly recommend that if you consider Purchase order financing that you enlist the services of a trusted, credible and experienced Canadian Business Financing Advisor with a track record of business finance success who can assist in maximizing your cash flow and working capital with this unique innovative type of financing.