Introduction
Contract finance is a funding solution that comes in handy for businesses with a signed contract for a large order, but don’t have the financing to purchase the supplies or finance for the resources to complete the work. Funding is then required to complete the order. Purchase order funding is an example of contract finance, particularly when you need a large amount of financing.
Purchase ordering funding is also known as working capital finance. It is when a lender agrees to buy the raw materials or to source the goods on behalf of you so that you can complete your purchase order. The lender takes back their share of the profit when the customer pays you for the purchase order. Purchase order finance bridges the gap between order and payment and has the advantage of being faster and easier to obtain than a traditional bank loan.
The lender sees you as a business partner and requires you to pay a profit share of the purchase order deal. The lender (or funder) is the one who takes the responsibility of paying the suppliers and makes sure that the goods and services are delivered to the customer on time.
Lenders of purchase order funding do not require credit checks. Luyanda Jafta from The People’s Fund explains: “We [the lenders] don’t need to do a general affordability assessment which includes credit checks, financials and statements of assets and liabilities. We only need to assess if your current order has a large enough margin for us to finance it.”
However, as part of the application criteria, many lenders may require that businesses have a track record of supplying goods and services.
Main Features
Convenience
You can apply for purchase order funding online. Lenders require finance seekers to apply online, fill in a form and a sales representative of their company will contact you. Some even offer to communicate with you via WhatsApp. You will be required to send documentation, but you don’t have to do any credit checks or do an affordability assessment.
Transparency
Each lender has specific conditions, which include that your purchase order must not be lower than a particular amount (for example the purchase order must be a minimum of R200 000). Each lender will inform you that they only work with businesses that have a purchase order of a certain percentage of the gross profit margin (example: gross profit margin must be more than 20%). You can get information upfront on how much the deal will cost you, including how much of the purchase order deal you will have to share with the lender.
Type of Loan
This is a working capital loan whereby you ask a financier for a large amount of money. The amount of the purchase order can vary from R50,000 up to R2-million (depending on how big the purchase order is).
Application Process
You will be required to apply online. Lenders require information such as your company name, company director’s full names, the debtor’s name, the value of the purchase order (including the VAT), and the supplier cost/ the invoice amount.
The documentation you need to apply for purchase order funding includes company registration documents; VAT certificate (if applicable); purchase order; supplier invoice; and the last three months bank statements.
Depending on the lender, if your application is successful, you can get funding within 48-72 hours. Once approved, the lender will pay the suppliers directly whether cash or a letter of credit.
Qualifying Criteria
To get a loan for a purchase order, your business needs to be distributors, outsourcers, resellers, wholesalers, businesses with heavily seasonal sales patterns, and businesses with tight cash flow and a need to purchase materials before fulfilling orders
Many lenders require that you have a trading history of at least twelve months, generate a certain amount in revenue per year (example: expecting to generate a minimum revenue of R1 million annually).
The lenders will also look at the credit-worthiness of your customer. Some lenders have a preferred customer list; these are customers that they have worked with before and deem as reputable. This means that if your customer’s name is not on the list of a lender, they might not approve your funding application.
Another requirement is that the delivery date of your purchase order must be reasonable; many lenders request that your purchase order be completed within 60 days.
Repayment Terms
The gross profit margin must be above a certain percentage (for example a minimum of 20% of the gross profit) on the purchase order, or else the application will be rejected.
While there is no interest charged on the loan, a flat fee will be charged to facilitate the capital to complete the purchase order. If the supplier is not VAT registered, the VAT costs will be on you. Other costs include the supplier VAT cost transfer.
Buyer's Guide
To determine whether a financing product is suitable for your purchase order, you must look at what their conditions and requirements are, which includes how much profit share they require.
Consider the following when looking for financing for your purchase order:
- The gross profit margin of the purchase order will determine whether your application is approved or rejected – Some lenders ask that the gross profit margin not be less than 20% or even not less than 30%.
- The purchase order size could determine which lender can assist you – Each lender has a minimum amount that they would provide funding for.
- Your business’s track record may be considered – Some lenders ask that businesses have a trading history of a minimum of twelve months and have a track record of supplying goods and services.
- Preferred customer lists are common – Some lenders will have a list of customers (the buyer) who they want to work with and who is deemed as reputable, especially if it’s your first time partnering with the lender.
- No hidden fees – You will be charged a flat fee and there is information available prior to the application process on how you will be charged.
Benefits of Purchase Order Funding
- You pay the lender back when the client pays your invoice – Payment is usually made after the project is completed.
- The financier (lender) takes care of paying the suppliers -The lender makes sure that the client’s services are delivered on time.
- You know what you are paying for – Before even applying for the purchase order funding.
- You can take on large projects or large orders – Because you can get funding for it within two days (or more – it depends on the lender’s turnaround time).
- Your bad credit record won’t matter – All you need is to show that you have experience in supplying goods and services, and also that your client is reputable (a preferred client by the lender).
- Risk is largely calculated – On ability to deliver on PO, and the payer.
