Purchase order financing and receivables factoring are two asset-based financing options that a number of companies are turning to. Both are ideal sources of immediate capital for enterprises that deal with long receivable collection times. While these options are similar, there are some very important differences. Any company pursuing these financing options should be cognizant of these differences before moving forward. So what are these differences and what makes these solutions so appealing for today’s companies?
Factoring of invoices is a process where a company immediately forwards an unpaid customer invoice to a financing company. The financing company assess the account debtor’s ability to pay the invoice, the age of the invoice, the amount of the invoice and finally, the account debtor’s payment history. Once all checks are complete, the factoring company advances 80 to 90 percent of the open invoice as credit. The company is now able to access working capital without having to go through the process of waiting for their customer to pay their invoice.
Purchase order financing operates differently in that the financing company advances the company funds based on the value of the purchase order they’ve secured. Once an order is received, the company forwards the order to the financing company. An assessment is made on the value of the order. Once all checks are completed, the financing company establishes a credit line where the company can draw upon the value of the open purchase order. This allows the company to secure the raw materials needed to complete the order, while also allowing the company to finance its daily operations. Blanket orders, long-term contracts and single purchase orders can be used as a form of collateral with purchase order financing.
In both cases it’s the financing company that assumes the role of collecting on the invoice. Once the customer pays the invoice, the company is reimbursed the difference between its original advance and the customer’s final payment. Fees are applied and a rolling credit line is open to the company so that it can continue to draw upon future open orders and receivables.
Ultimately, the difference between receivables factoring and purchase order financing comes down to timing. With receivables factoring, the company uses its receivables as a form of collateral. In this case, the company only secures working capital after it has invoiced its customer and forwarded that invoice to the financing company. With purchase order financing, the advance comes much sooner and the advance is based on the total value of the open order or contract. Both are flexible financing options for companies who operate in industries where long receivable collection times are the norm.