Purchase order financing and factoring are two similar methods that allow you to finance inventory from the customer before the sale is made. There are distinct differences between the two, however, they should be known to help you decide which method will work best for your business. Before comparing purchase order financing and factoring, it’s important to have an understanding of what each one does in the first place. Once you have a better idea about how these two functions differ, you’ll be able to choose which one will work best for your business and why.
The Advantages of Purchase Order Financing
A major advantage of purchase order financing is that it allows you to finance inventory that has already been ordered by your customer. This approach takes some of the risks off your shoulders. Once your customer has paid for their goods, you will be able to repay most or all of your purchase order financing at one time. This method also helps you ensure payment for future orders on which your customers have not yet paid, but are sure to do so when they receive their first shipment.
The Advantages of Factoring
Factoring can help you when your business needs access to funds, but you haven’t built up enough credit yet. The lender will pay your customer on behalf of your company, and then expect you to repay the principal amount plus interest out of future sales. This allows you to focus on what you do best without worrying about long-term debt repayment. It also frees up more cash flow to reinvest in your business. Purchase order financing is similar in that it provides businesses with instant cash through a line of credit, but this option doesn’t come with the added security or flexibility offered by factoring.
The Disadvantages of each
Purchase order financing may be appealing because it is a way to get around funding your business without having to work with a bank. In contrast, many small businesses use factoring to get cash upfront before taking their product or service out into the world. The downside of using purchase order financing is that it can be expensive, complex, and risky; because there are a lot of uncertainties that come along with it.
Best Practices for each
Purchase order financing involves a company using its own accounts receivables or cash on hand to finance its own operations. The company then sells invoices at discounted rates to investors with its purchase orders as collateral. The only downside is that by providing these invoices, there is no physical collateral if things go wrong. It may also take longer to receive funds since they are coming out of your own accounts receivable.