The Role of the Purchase Order in Business

Purchase order management has always been a critical part of keeping cash flow liquid. With more and more business and supply-chain interruptions, however, it’s become increasingly difficult for smaller businesses to stay liquid and earn productively in a difficult business environment. Luckily, there are some strategies you can use to help offset this uncertain business environment, including purchase order financing. Let’s take a closer look.

The Role of the Purchase Order in Business

Purchase orders are official documents sent by a business to an external vendor or supplier, securing their intent to purchase a set amount of goods (or services). Once the supplier approves and accepts the purchase order, it becomes a binding document under law, making it a critical part of the overall procurement cycle.

Purchase Order Management is a critical part of any business. Talking holistically, it’s the practices you’ve established to ensure your information on in-action purchase orders is always available and up-to-date. Even a small error, or a minor-seeming redirection of communication, can lead to complications that bring the purchasing cycle to its knees. In turn, this has knock-on effects on the ability of the business to deliver to customers- and can freeze cash flow in its tracks.

What is Purchase Order Financing?

Cash flow issues around purchase orders arise in two ways:

  1. You need the funds available to procure the service or goods, typically in advance to when you’re able to charge the end client for the overall order. This is less of a problem in businesses able to maintain a sizable ‘slush fund’ to roll over into the gap, but for small businesses with tight budgets, large orders can become problematic.
  2. You may not work on immediate payment, especially for your most important or largest clients. Sometimes, payment will only be sent after 120 days! Again, if you don’t have a sizeable budget to ‘float’ this cost until the end payment is received, it can cause significant cash flow issues in your business. Especially if there’s more than one delayed payment!

Purchase order financing, sometimes called PO financing in the industry, uses a third-party finance company to fund your purchase orders and smooth cash flow fluctuations. This makes it a popular option for those who need an effective, easily-accessible solution to financing their purchase orders while keeping cash liquid. Think of it as a form of bridge-financing specific to the purchase order arena.

Pros and Cons of Purchase Order Financing

As it is, effectively, a line of credit, there are pros and cons associated with purchase order financing.

Pros of Purchase Order Financing

Of course, the major pro for purchase order financing is that it helps avoid cash flow problems in a smaller business while waiting on fulfillment and the payment of the end client. They also:

  • Help preserve and grow revenue when smartly used
  • Even the playing field for start-ups and small business
  • As risk is calculated on your ability to deliver (and your client’s likelihood of paying), it can be an effective helping hand in smart, but small, businesses

Cons of Purchase Order Financing

There’s always some cons in any credit line. Typically, those you will run into with purchase order financing include:

  • The possibility of a ‘minimum’ margin on the deal, where only orders of a certain dollar value will be financed
  • Some lenders work from a ‘joint account’-style setup, ensuring they receive their funds immediately when there’s payment on the order. This can introduce some security risk to the transaction.

Many of these risks can be mitigated by choosing an ethical purchase order financing partner, and ensuring they work with businesses with your typical cash flow and order parameters.

Purchase order financing can be a valuable business tool for the right small business, and take the weight of length procurement cycles off of your limited liquid funds.

Interesting Related Article: “How to find the best Purchase to Pay Solution for your Business