Determinig When To Use Purchase Order Financing

As with factoring receivables, an important part of purchase order financing involves knowing when it makes sense to use it. For some companies it is clearly a bad idea, and for others using purchase order financing makes perfect sense. However, for many companies the decision is not so clear and some calculations should be made to determine if purchase order financing will produce a good return on investment.

Determining Your Minimum Cash Balance

Making decisions about purchase order financing is easy if you do your homework up front. The key to making these financing decisions involves finding your minimum cash balance. Once this is done, you should utilize financing when your cash balance falls below the minimum and avoid it when the cash balance is higher.

The equation for determining the minimum cash balance is:

We covered this equation in detail in our section on factoring and accounts receivable finance. We recommend reading that section if you have not yet done so. Basically, the equation looks at the opportunity cost of not having available cash. In other words, by not having cash on hand what opportunities are you missing out on.

This same analysis is useful for purchase order financing decisions.