Purchase order financing enables businesses to finance large quantities of products while they're in inventory. Businesses take out a short-term loan that typically terminates sooner than traditional business loans.
Step 1: Your Business Receives a Purchase Order
When another business places a purchase order, they're asking to purchase a specific type and quantity of goods from your business. You can evaluate the order to determine whether you do indeed need financing. Assuming you do, the order grants your business access to purchase order financing.
Step 2: The Financing is Obtained
You discuss the order with your supplier, who will need to know the specific product types and quantities. These details will let your supplier determine the cost of making the purchase order, and, thus, how much financing your business will need.
You can then apply for financing, which may be provided by the supplier or a third-party lender. Depending on your past history, your business might be able to finance the entire purchase or a significant portion of it.
The supplier receives the funds (or releases them), so they can pay for the materials and labor needed to produce your products.
Step 3: You Receive and Sell the Products
Once the supplier has your products ready for delivery, you accept the delivery and then sell it to the original customer that made the purchase order. Since the terms of purchase are already agreed upon, selling the products to the customer is normally straightforward.
Step 4: The Loan is Paid Off
Once the customer receives the products from you, finances can change hands to pay off the purchase order financing. How exactly this is executed depends on the terms of your financing and your preferences.
Sometimes the original customer pays off your purchase order loan directly. You only want to allow direct payment if the financier is a third party, as putting your customer in contact with your supplier could lead to you losing out on future sales. Additionally, you might still be contacted if the customer fails to remit the necessary payment.
You alternatively can collect payment from the customer, and use the payment to pay off the purchase order financing yourself. You should do this if you finance with the supplier or financed only part of the supplier's charges. You may still want to do this if you financed the full amount with a third party, as remitting payment grants you more control over the process.
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