Purchase order financing is one way to fund the manufacture of products. In this type of borrowing, money is advanced by a factoring company against a purchase order in order to finance the production of the goods in question.
In order to better understand this type of financing, Richard Eitelberg, a CPA who is founder and president of Hartkso Financial Services LLC (www.hartsko.com) has written a piece for us that explains the concept. Hartsko is a purchase order finance / letters of credit firm located in Bayside, New York which handles approximately $180 million dollars in annual revenues.
If there is any group of products, inventory, and merchandise which works simpatico with “purchase order financing”, it is toys. This is usually because the spreads and mark-ups for the toy industry from manufacturers-to-distributors-to-retailers have significant room and leeway.
I have a number of toy importers who have become “purchase order finance” clients in the past several years mainly because their banks eliminated their credit lines or drastically reduced them. It’s not even necessarily because of poor operating practices on the part of these business owners. Rather, so many banks have been ordered by regulators that they must close any account relationships which pose risk or show weak credit scores. Then, there is the perception on the part of bankers that retailing has suffered heavily in this economy, so therefore the toy business owners must be going through distress.
Purchase order financing is more expensive than bank financing. Given the margins often present in toys, an extra percentage or two for purchase order financing is worth it when compared to the aggravation and distraction of bank demands in this climate. There is the peace of mind a business owner receives in knowing that the purchase order financier is usually ready to go and will not be bureaucratic, or bailout altogether on credit requests.
Let’s say a toy distributor obtains a retail order for $100,000. A purchase order finance firm guarantees that they will pay for the manufacturer (the distributor uses) for the product through a letter of credit. Especially for toy dealers, considering that most of these orders are produced in China, more so than in other sectors like perhaps, garments or electronics—product liability insurance is very important, along with inspection standards to avoid or minimize returns from the retailer.
After the goods are shipped and have properly arrived at the retailer’s destination the purchase order finance firm gets “taken out”. This money may come from the retailer, the business owner client, a bank, a factor, or an asset-based lender. Under current credit conditions, the toy business is looking at fee-based payments to the financier of 2-3% per month. Keep in mind that purchase order financing is only used when it is absolutely needed. It is transactional and temporary. I fully expect with all of my clients that if they can access funds from a bank, private equity, or some cheaper source—they are going to use that option.
The benefits of purchase order financing for the business owner is that they have been given the ability to transact their deal and earn a profit, which (beyond the financing fees) still could represent anywhere from 25% to 50% or more. Purchase order financing over a period of thirty, sixty, ninety, or even 120 days has given this business owner “cash flow breathing room”. It becomes especially important with toy distributors who are many times dependent on one season in a pressured race to consummate all of these deals. Purchase order financing assists them with purchasing power and extra financial capacity.