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If your business sells products to other businesses on credit, you may sometimes struggle with cash flow. There may even be times when you don’t have enough funds to accept a new purchase order, since every job requires an outlay of cash. That’s when you might turn to a short-term financing option like purchase order financing or invoice factoring.Purchase order financing helps your business buy goods needed to fulfill outstanding customer orders, while invoice factoring allows you to get paid for jobs you’ve already done but have not yet been paid for. Both types of financing are fast to fund and relatively easy to qualify for. On the downside, both can come with high costs.Here’s a closer look at purchase order financing vs. factoring, why you might consider one or the other, as well as other financing options that can help bridge gaps in cash flow.
What Is Factoring?
Factoring, also known as invoice factoring or accounts receivable factoring, is a type of financing that allows you to trade your unpaid invoices in for immediate cash rather than wait the 30 to 60 (or sometimes 90) days it can take to get paid from your customers. How does it work? With factoring, you sell some or all of your company's outstanding invoices to a lender known as a factoring company. Typically, the factoring company will pay you up to 80% or 90% of the invoiced amount immediately. It’s then the factoring company’s job to collect payment from your customers. When they do, they pay you the remaining balance of the invoice, minus their fees.
Pros and Cons of Factoring
As with many types of business financing, there are both benefits and drawbacks to factoring. Here’s a look at how the pros and cons stack up.
Pros
Fast form of funding With factoring, you can typically get access to capital much faster than you can with more traditional types of small business loans.
Allows you to offer customers attractive payment terms Customers often appreciate long payment terms. Factoring allows you to give them this option yet still access cash right away.
Relatively easy to qualify for You can often get approved for factoring even if you have poor or thin credit and no collateral. Factoring companies are generally more concerned about the creditworthiness of your customers, since they will effectively be repaying the debt.
Cons
Can be costly By using factoring, you won’t get the full amount of the invoice, since the factoring company takes a cut. Rates can range anywhere from 0.50% to 4.00% per month, which is higher than typical business loan interest rates when converted into an annual percentage rate (APR).
Risk involved The longer it takes your customer to pay, the more the factoring will cost. And should they fail to pay, you may have to repay the amount the factoring firm has already paid you.
Your customer will know you’re using financing With factoring, your customers pay their invoices to the factoring company, not your company. As a result, they will be aware that you are having issues with cash flow.
What Is Purchase Order Financing?
Purchase order financing works a little differently than factoring. It also comes into play earlier in a B2B business deal. With purchase order financing, a lender provides you with the funds to purchase goods or materials you need to fill a customer order. It can come in handy if your business is new, or you’ve received an especially large order and you don’t have the cash you need to fill it. Rather than turn customers away, you can turn to purchase order financing. How does it work? Typically, the lender pays your supplier up to 100% of the cost involved to produce and deliver goods to your customer. The supplier then fills the order and sends the product to your customer. At that point, you invoice your customer, who sends payment directly to the lender. The lender then deducts their fees and sends you the balance.
Pros and Cons of Purchase Order Financing
Just as with factoring, there are advantages and disadvantages to small business purchase order financing. Here’s a look at how the pros and cons stack up.
Pros
You can fill orders you otherwise wouldn’t be able to take Even if you're short on cash, you can still serve your customers or handle a sudden uptick in business.
Relatively easy to qualify for Purchase order financing tends to be easier to qualify for than other types of small business loans. Purchase order financing companies are generally most concerned about the creditworthiness of your customers and the reliability of your supplier.
No loan payments to make Since purchase order financing is more of a cash advance than a loan, you won’t need to pay the money back in regular installments like you would with a regular term business loan.
Cons
Can be costly Purchase order financing rates may seem relatively low, often running between 1.80% to 6.00% of the purchase order value per month. However, If you convert it to an APR, it can come out to more than what you pay for other kinds of small business loans.
Cost is hard to predict Since fees are charged per month, how much you will end up owing the financing company will depend on how long it takes your customer to pay their invoice. This can make it difficult to estimate the total cost upfront.
You lose some control With this type of financing, you’re often cut out of the order fulfillment process. Typically, the lender pays the supplier, the supplier ships the product to the customer, and the customer pays the lender.
Purchase Order Financing vs. Factoring: The Differences
On the surface, purchase order financing and invoice factoring may seem similar. Both are types of short-term financing designed for companies that rely on invoicing their customers for payment. In addition, both fund most of the purchase orders or invoices involved, and look at the creditworthiness of customers to determine funding amounts and rates. However, there are also some significant differences between these two financing options. The biggest ones are who receives the funding and when they receive it. With invoice factoring, a factoring company pays your business cash in exchange for invoices on jobs you’ve already completed. With purchase order financing, a lender pays your suppliers to fulfill a customer’s new purchase order.
Which Is Right for You?
Whether purchase order financing or factoring is the right fit for your company will depend on the type of business you have and what you need the funds for.If your business relies on a third party to supply or manufacture the goods that you sell, and you sometimes struggle with cash flow, you might consider purchase order financing to help bridge the gap between orders and payments. If, however, you’ve already completed a purchase order and sent the invoice but need cash while you're waiting to get paid, you might consider invoice factoring.
Qualifying for Purchase Order Financing or Factoring
Qualifying for purchase order financing or invoice factoring tends to be easier than qualifying for other types of business loans. While the lender will likely look at your credit score and your company’s financials, they will probably look most closely at the other entities involved in the deal, namely your suppliers and customers. With invoice factoring, it’s up to your customers to pay their outstanding debts. With purchase order financing, the lender will want to make sure your supplier and your customers will be able to keep up their ends of the deal.Fortunately, that means business owners with poor or thin credit might still qualify for purchase order financing or invoice factoring.
Alternatives to Purchase Order Financing and Factoring
Purchase order financing and factoring aren’t the only ways to bridge short-term cash flow issues. Here are some other options to consider.
Invoice Financing
Invoice financing is similar to invoice factoring but with a few significant differences. With invoice financing, you don’t sell your invoices to a third party. Rather, you use your invoices as collateral to get a cash advance from a financing company. With invoice financing vs. factoring, you still own the unpaid invoices and remain responsible for collecting payment on them. After the customer pays the invoice, you’ll repay the original advance amount, plus fees, to the lender.
Small Business Loans
With a term business loan, you receive a lump sum of capital upfront and then pay it back (plus interest) in regular installments over a set term. While banks typically have strict criteria and a long underwriting process for business loans, online business lenders tend to have more flexible requirements and are faster to fund. A short-term business loan from an online lender can help solve a short-term cash crisis, but rates and terms are generally higher than bank loans.
Business Lines of Credit
You can also use a business line of credit for flexible, short-term financing. Similar to how a credit card works, a line of credit allows you to draw up to a certain limit and only pay interest on the money you borrow. You then repay the funds and can continue to draw on the line. You can use a business line of credit for a variety of immediate needs, such as managing cash flow, buying inventory, or paying employees.
Compare Business Loan Rates
If you’re curious about what types of business financing you may be eligible for, Lantern by Sofi can help. With our online lending tool, you can compare offers from top small business lenders matched to your needs and qualifications. By filling out a single application, you get access to multiple loan options, including short-term loans, business lines of credit, and invoice financing.Let Lantern by SoFi connect you with the right lender for your small business financing needs.
Frequently Asked Questions
What are the differences between purchase order financing vs. factoring?
Is a purchase order a promise to pay?
Can you get a loan with a purchase order?
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About the Author
Susan Guillory
Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
