For many small businesses, the underlying issue is less about the capital and cash you have access to, as it is managing it well. As we face supply-chain interruptions, the gap between needing to order components and supplies, and receiving payment from your clients, is stretching wider and wider. How do you continue to operate productively, without finding yourself in a non-liquid cash trap that leaves you unable to meet your customer’s expectations or drive new sales? Let’s take a closer look at this thorny issue.
Purchase Orders- The Liquidity Cash Trap
For many small businesses, especially those that deal in goods, it’s the point at which you have to pay your suppliers or vendors for a purchase order, but haven’t yet received client payment, that creates the most chaos in your cash flow. Purchase orders, once accepted by both parties, serve as a binding legal document, so they’re a critical part of your overall procurement cycle. They demonstrate your intent to purchase a specific set of goods or services from an external supplier. Often, they need to be paid in full before delivery of the goods can be made.
Of course, you can do a lot by simply staying on top of these orders. No sense in having paid for something weeks ago, and still need to tell your client you can’t deliver. Small failures in communication, or minor errors that prevent the vendor from delivering, can enact huge delays in your supply chain and bring your purchase cycle down around your ears. In turn, you can’t deliver to customers, and your cash flow dwindles to a trickle.
Many small businesses have failed, not due to mismanagement, lack of drive, or a poor idea, but because they can’t solve this issue of keeping cash flow balanced while still furthering business goals. Looking for alternatives to self-funding the procurement cycle can be one of the smartest steps you take as a smaller business, especially with the right finance partner to work with you.
How Purchase Order Financing Can Step Into The Gap
However, even the most meticulously managed purchase order process can still leave you in a cash flow shortage, no matter how good your accounts receivable look on paper. How does this happen?
- Businesses need to fund their purchased third-party goods well in advance to the point at which the end client pays for them. That’s why larger businesses, with more free liquidity, will maintain slush fund-like accounts to provide a buffer for this circumstance. All is well and good, but much more difficult for start-ups, small businesses, and even medium enterprises to achieve organically. This means large orders- the very thing you need for success- can quickly eat up your free cash and leave you in dire straits.
- This issue is then exacerbated by your end client’s payment cycle. While some small businesses can get by on immediate payment, your most attractive, large-scale clients typically won’t work on a pay-on-presentation system. This leaves you idling, with all the cash outflows still in play, and no incoming cash to offset it. With some larger corporations operating on anything up to a 120-day payment cycle, it’s easy to find yourself in an untenable position quickly.
While not right for every business, purchase order financing (PO Financing) allows you to leverage a third-party credit source to help you keep funds active in your business instead. It’s becoming a popular option as an easily-accessible and efficient way to finance purchase orders outside of your existing liquid assets. In other words, bridge-financing with a special niche focus.
The Benefits and Disadvantages of PO Financing
As with any other credit source, there are both benefits and disadvantages to using a purchase order finance company. Let’s take a look at some of the key issues.
Positive of PO Financing
As we’ve already seen, the biggest advantage that PO financing offers you is escaping the liquidity trap and keeping cash flow within your organization balanced, even while you wait on vendors and clients to carry their ends of the deal. That’s not all they offer, however.
- Ethical PO finance companies calculate a risk score for businesses using their services. This means that a well-run business can leverage good behavior to reduce associated costs, lending you a helping hand to reward your good management
- PO Financing helps you to better manage, preserve, and grow your revenue streams when used correctly. You might be able to attract a better class of clientele or bring in more revenue, with their help.
- Start-ups and small businesses get to leverage an advantage typically only open to larger concerns, evening the business playing field.
Disadvantages to Purchase Order Financing
While PO financing is a smart tool in the right hands, any line of credit comes with its downside, too. Some that you might encounter with PO financing include:
- Only being able to access purchase order financing within ‘minimum margins’. This means only certain orders which meet a specific dollar amount are eligible for finance. This can be problematic if you use many small third-party vendors, instead of one or two bulk orders.
- To cover their own investment, the purchase order financing company may need you to establish a ‘joint account’ so that they can deduct their due balance the second you are paid for the order. While this is generally safe if you have chosen a financier with a good reputation, it does remove some of your executive powers and can be something of a security issue if mismanaged.
- Overextending yourself with credit is always a risk in any small concern. Rather than chasing a lot of credit, work with one established firm and within your means.
Of course, many of these issues can be reduced by working with the correct purchase order finance partner. Look for one who works with businesses like yours, understands your industry, and caters to the size of order and cash flow circumstances relevant to your business.
While not the right solution for every business, in the right hands PO financing can become a potent business tool that helps you offset lengthy procurement cycles and keep your precious cash flow liquid and working to your advantage.