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Understanding PO Financing

Many small businesses are just that, small, so they often hire other people to produce the goods needed to fulfill an order. The problem is, sometimes the small business does not have the money to pay for the goods until they get paid for them.

Here is how P.O. Financing works:

A creditworthy customer issues a purchase order for goods. This is where they say they will pay for goods once they are delivered.

The small business (the borrower who needs P.O. financing) will then negotiate with a supplier to fill the order.

The supplier wants cash upfront or some sort of guarantee of payment. However, because the customer is not going to pay until they get the product, the company doesn't have the cash to put upfront. So in other words, they have an order, but can't fill it because they lack the capital to guarantee shipment.

P.O financing is when the supplier feels confident they will get paid so they go ahead and produce the goods and drop ship them to the customer.

The only way a supplier feels confident is because a finance company steps in to guarantee payment. This can be a good way to get a third party to supply your customers if you do not have the capital to do it yourself. If you opt for this, the finance company will likely do the following:

1. They will check to see that the purchase order exists and has been legitimately issued. In other words, did someone place the order?
2. Then once the order is verified, the finance company will verify the credit worthiness of the purchaser. They want to make sure that they know the buyer or order has the money to pay the final bill.
3. Once that is verified they will then check the supplier. They will want to make sure that they are doing their job, sending the goods to the right place, within the right timeframe, and for the right cost breakdown.
4. Once all of this is done, the P.O. finance company will issue what is called an Irrevocable Letter of Credit made out to the supplier. The supplier then has to fill the order and ship it. Once the supplier ships the goods, has the order inspected, and the required documents sent to the bank, the supplier will be able to invoke the letter of credit and get paid out by the bank.

Small businesses should be aware of this financing option, as it could help free up some cash flow and allow you to fill orders you did not think you had the ability to fill in the past. The drawbacks are that the order leaves your hands, and you do not see the goods at all, which means you have to be careful about the supplier. In addition, you have to be careful about the credit worthiness of your customers as well, as that is how you pay back what you owe.

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