WHY IS IT NECESSARY?
As an example, my company manufactures $1,000,000 in widgets every month. The orders come in and I am able to fill each order. However, one of my customers calls me and states that he/she is looking for $1,000,000 in widgets for the next month. Obviously I want to fill this order and basically double my production and profit for that month. This is an important customer and will move their orders to one of my competitors if I am unable to meet their needs.
My problem is that I am geared for $1,000,000 per month and my financial position allows for that level of production and very little more. My line workers are currently working at their maximum capacity and any additional production would entail hiring additional workers and/or paying the current staff overtime to meet this order. If I work my employees beyond their normal working hours this will increase my utility costs also. More raw materials will be required to fill the order. All of this requires an influx of capital to keep on top of these additional costs. I have already pledged all my assets for other lending that my company has received and am just at the end of my borrowing capacity. What can I do?
SOLUTION FOR LACK OF CAPITAL
My customer is willing to issue a written purchase order for the goods needed. Therefore, I have a guarantee of selling the widgets after production. Purchase Order Financing can be my solution. I borrow funds from the PO Financer to cover my upfront costs to manufacture the additional widgets. The PO Financer uses the Purchase Order as their security for the loan.
REQUIREMENTS FOR FUNDING
The minimum gross profit margin will be 50%.
Order to delivery time to be no more than 6 weeks.
3The order is to be shipped all at one time so that entire amount of the invoice generated will be due and payable.
4PO Financer will perform due diligence on both my customer and my company to determine:
a.My ability to produce and deliver the goods.
b.My customer’s ability and willingness to pay for the goods upon delivery.
PO Financer charges 4.5% interest per month until total advance is paid back.
BENEFIT TO CLIENT:
I have the ability to meet the order from my customer thereby retaining the customer and substantially increasing my profit for that time period.
WHAT HAPPENS WHILE CLIENT WAITS TO BE PAID BY CUSTOMER?
The PO Financer is charging me 4.5%. This is a huge financial burden and can be offset very easily. When I deliver the widgets I generate an invoice to my clients which is all due and payable as all goods have been delivered. My customer passed the due dili-gence investigation of the PO Financer because they always pay their bills. My problem is that the customer takes 60-90 days to pay. This would cost me 13.5% on the money borrowed from the PO Financer. So what can I do? Factor the invoice. Once I have sold the invoice to the factor I receive 70-90% of the invoice value as an advance and can easily pay back to PO Financer as they have only advanced based upon a gross profit of 50% so I will be 20-40% ahead after paying the PO Financer. When my customer pays the invoice I will receive the balance of my reserve account after paying the discount fee to the factor.
STEPS IN THE PROCESS
- Purchase Order from customer for $1,000,000
- Request for $500,000 from PO Financer resulting in 50% gross profit as required by them
- Due diligence in both manufacturer and customer
- Advance against PO
- Manufacture of goods
- Delivery of goods and invoice generated
- Invoice offered to Factor
- Due diligence by Factor
- Sale of invoice to Factor and advance to manufacturer
Once I have sold the invoice to the factor I receive 70-90% of the invoice value as an advance and can easily pay back to PO Financer as they have only advanced based upon a gross profit of 50% so I will be 20-40% ahead after paying the PO Financer. When my customer pays the invoice I will receive the balance of my reserve account after paying the discount fee to the factor.
ACCOUNTS RECEIVABE FINANCING
- This is a popular method of financing working capital requirements for a growing business.
- This financing enables a somewhat illiquid asset (e.g. accounts receivables) to be converted into cash immediately.
- This financing is not intended to supplement capital for grossly undercapitalized firms in a rapid growth period.