Purchase Order Financing Canada

Purchase order financing services are commonly misunderstood within Canada and throughout the business financing industry. In part, this is probably because the name is both generic and very enticing. Most businesses make the assumption that PO funding will simply provide their company money (directly), using POs as collateral. Unfortunately, this is not the case. There are two primary types of purchase order finance services utilized by borrowers (1) Finished Goods and (2) Production.

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Canadian Purchase Order Finance Company

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Here is how a transaction is commonly structured. Let’s assume that you are a distributor and your customer has placed an order with you to buy $100 worth of widgets. Let’s also assume that your supplier charges you $50 for those widgets.
Additionally, your supplier wants you to prepay that $50, but your company does not have the capital to pay for the goods in advance of delivery. This is where purchase order financing comes in. The financing company can help you complete this sale by structuring the following transaction (assuming you have a financing contract in place).

There Are Two Options – How It Works?

(1) Finished Goods

The borrower is outsourcing manufacturing of the product. Some form of credit enhancement such as LCs or cash funding is required to pay the contract manufacturer for the finished product. Some of the transaction risks include of Finished Good Purchase Order Financing in Canada include:

  • Credit worthiness of the end-buyer
  • Sufficient gross margin in the order
  • Ability to verify the order (i.e., is it a firm order, guaranteed sale or something in between)
  • Managing the quality control/inspection aspects of production
  • Managing the logistics and physical control of the product being funded (i.e., can delivery times be met?; what happens if the goods are in control of the borrower and they use the products for orders not financed by the PO finance source?)
  • Order cancellations; ability to sell the products to another party
  • Factor or ABL’s advance rate — adequate to repay PO finance source? Inter-creditor issues?
  • Will the supplier accept an LC, cash upon shipment or require cash in advance (essentially an unsecured loan)?

(2) Production (ie. Work In Process)

This is utilized by domestic manufacturers or assemblers that procure the necessary components and/or raw materials to “make” or “build” a finished product either in their own facility or using sub-contractors or assemblers. Elements of Canadian Production Purchase Order Finance Services include:

  • Need for proven history of producing the product, available capacity and the cash-flow to cover other non-direct costs. PO finance can include the cost of materials, parts and direct labor to fulfill the order.
  • Is the company profitable or cash-flow neutral? The order being financed should represent incremental sales to the company (i.e., if the company lost the sale, it would still be a going concern).
  • Number of suppliers being utilized in the transaction? The greater the number, the more due diligence required to qualify the suppliers and control the collateral of raw materials/parts delivered to the company.
  • Length of the production cycle? Days and weeks are much better suited for this type of financing. If the production cycle is more than 90 days, the cost of PO finance and the risk associated with the longer exposure of employed funds might not make economic sense for either party.
  • What does the company do in production? Fabricating, cutting, sewing, mixing, packaging, etc. are usually acceptable. Production involving tooling, molding, milling, etc. in producing a finished product is more challenging.

Save Money: The EBF Advantage

Business owners sometimes get confused at point #5 below. Why bring in a factoring company? The reason is simple: combining with factoring using the same financier often yields a lower total transaction cost on the PO funding aspect than if you were using the service alone. This is because the factoring company is handling the entire process and will therefore give better purchase order financing rates on transactions where factoring will also be in play. However, given the fluid nature of these transactions, you should double-check the numbers to make sure that combining is the best solution for your transaction.

 

What This Service Is NOT!

Purchase Order Financing in Canada is not an over-advance on inventory, nor is it utilizing the factor credit balance and thus lending more on accounts receivable. Finally, it is not obtaining outside additional collateral to support the existing senior lender’s rationale to lend deeper into the credit. While these may be satisfactory solutions, it may not be enough for the borrower and use of these items may end up reducing the cushion the senior lender relied on in the event of a downturn in the borrower’s performance.
In conclusion, this service has become a main stream funding solution for medium and small business owners. However, providing purchase order financing to companies in Canada comes with a high degree of risk requiring a skill set not usually found in a factoring or Asset Based Lending environment. While the need to employ capital (driven by impatient investors as part of a financier’s capital structure) and generate higher returns are a challenge, the senior lender should consider teaming up with a purchase order finance company who is reputable, highly experienced, well capitalized and has demonstrated the staying power to support small and large transactions across a variety of structures and industries. By sticking to one’s skill set — the bank, factor, ABL and PO company each doing what it does best — a solution can be provided for the borrower that also leads to a more safely managed transaction to everyone’s benefit.

  1. The purchase order financing company reviews the transaction to ensure that it complies with the funding requirements.
  2. The purchase order financing company pays $50 to your supplier directly. Depending on the circumstances, payment may be made by letter of credit or by wire transfer.
  3. Once the payment has been received, your supplier manufactures/releases the widgets.
  1. The widgets are delivered to the customer, who inspects and accepts.
  2. At this point you can invoice your customer. The transaction can proceed in one of two ways. You can factor the invoice and use the factoring proceeds to pay the purchase order financing company and close that line. The transaction would then proceed as a conventional factoring transaction. Alternatively, if factoring is not an option, the transaction can settle once your customer pays for the end goods.

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