Purchase Order Financing In Action

There are many situations where purchase order financing offers significant advantages to businesses. Below we will give a couple of examples of how different companies may use purchase order financing for different reasons.

NewStar Energy - Financing Rapid Growth

Some companies use purchase order financing when a business grows so quickly they surpass the lending ability of their traditional bank. In these cases financing companies can step in to provide the additional capital.

This example uses NewStar Energy, a small, but rapidly growing company in Virginia that has developed a solar panel solution that dramatically decreases the energy savings payback period. Home Depot has taken a serious interest in this product and has decided to put in order for 80,000 units. This amount far exceeds anything the company has produced in the past. NewStar executives are thrilled with the size of the order, but are worried about being able to fill it. Their current factory is not equipped to handle an order of this size and to expand their operations they need a loan.

The current economic climate has made their bank nervous about financing a large expansion for a small and relatively new company. Their bank determines that they can only lend 20 percent of the capital needed for the expansion.

NewStar then decides to approach a non-bank financing company that offers purchase order financing for the rest of the capital. The purchase order financing company is confident in NewStar's ability to fill the order if financed and decides to provide the additional financing needed. The fact that there is very little risk in being able to receive payment from Home Depot also adds to the attractiveness of the deal.

Now that the finance company has purchased NewStar's purchase order, NewStar can fill the order and expand their business.

Light Creek Footwear - Combating Seasonality in The Apparel Industry

Companies with seasonal products experience dramatic swings in cash flow. This volatility creates potential problems when they approach high sales periods. Companies in these situations may not have enough capital to ramp up production to meet the increased demand in high sales periods.

In this example, Light Creek Footwear produces seasonal footwear designed for peak performance in cold and wet conditions. The company's sales volume is extremely low in the spring and summer and spikes in during the fall. The spikes in sales come from major retailers submitting large orders to stock up on winter apparel. Producing these large orders requires a great deal of capital. Unfortunately, their bank is not able to provide the financing necessary to fund their winter production build up.

Light Creek could simply hold on to the revenue from the previous winter sales season, but that would be an extremely inefficient use of capital. Light Creek would be served best by investing that revenue back into the company or in other areas that can produce a good return rather instead of leaving the money in the bank for 6 - 9 months.

Purchase order financing provides a way for Light Creek to both invest their winter sales revenue in high return channels as well as fund their winter production build. When Light Creek receives their first few purchase orders for the winter, they can sell these purchase orders to a financing company. This injection of capital allows Light Creek to purchase raw materials from suppliers, hire additional employees, and boost production.

Without purchase order financing they would have had to either hold on to make inefficient use of previous capital by just holding on to it, or risk working with lower cash balances than they are comfortable with.