When you are researching funding options, it is not uncommon to encounter terms like “invoice factoring” and “PO financing.” What can be confusing is when these terms are used interchangeably. Each term refers to a different funding source that businesses can access at short notice. There are some similarities, which means that businesses in similar industries may choose one or the other depending on their funding situation. Learn the difference between invoice factoring and PO financing so you can choose the right financing tool for your business.
The first step when choosing the right funding source is to understand what each type of funding is and does. This glossary will help:
- Invoice factoring.Invoice factoring (often called simply “factoring”) is a type of financing accessible for both tangible goods-based companies and service-based businesses. With invoice factoring, your company essentially sells its existing accounts receivable to the funding partner. In exchange, your company receives funding up to a certain percentage of the total assessed value of your accounts receivable.
- PO financing. PO (purchase order) financing differs from invoice factoring in that it is a funding type only accessible to goods-based businesses. What is sold is not the value of accounts receivables, but of existing or proposed purchase orders. PO financing is often used when a company receives an opportunity to fulfill a new order larger than their current cash reserves allow for. PO financing offers fast cash to purchase the raw materials, supplies or other hard goods necessary to fulfill the order and grow the business.
There are several similarities between these two funding sources. If your business qualifies for both funding types, it is important to understand the similarities so you can choose the funding type that offers the best value.
- Both funding types have a quick and easy application process. In each case, the application and approval process turnaround time is typically less than five business days (sometimes it can take as little as 24 hours for approval and initial funding).
- Both funding types are based on an assessment of a single piece of financial data. Unlike with bank loans and other traditional funding sources, which often require an extensive financial review, invoice factoring and PO financing each review only one element. In the former, the value of the business’ accounts receivable is reviewed before approval is granted. In the latter, it is the value of existing or proposed purchase orders that is assessed.
While there are some important similarities between these two funding sources, and each was designed to be easily accessible to growth-minded businesses of any size, there are some key differences as well:
- Invoice factoring typically will not fund the entire value of the accounts receivable.The industry standard shows that a range of 70 to 90 percent of the value will be funded, with the remainder retained as a reserve.
- PO funding can fund up to 100 percent of the value of the existing or proposed purchase order.The credit worthiness and stability of the customer(s) is assessed as part of the approval process.
- Invoice factoring offers flexible funding. Many companies try factoring invoices to generate fast-working capital that can be applied to a variety of projects.
- PO funding can only be used to fulfill the purchase order. The funding application and approval process is equally fast, but the funds must be wholly dedicated to purchasing the raw materials or necessary supplies to fulfill the specific purchase order(s) the funding is tied to.
Choosing a Funding Source
The easiest way to choose a funding source is to identify whether you are a goods-based or service-based industry. Next, ask yourself whether you need flexible funding or you can afford to dedicate the full funding received to an outstanding order’s fulfillment. Finally, assess different funding partners and decide where you can get the most attractive terms. These elements will help you choose the best funding source for your needs.
About the Author: Raul Esqueda is founder and CEO of 1st Commercial Credit LLC in Austin, Texas. Raul has experience funding businesses of all industries and sizes in the United States, United Kingdom and Canada and has written many articles about purchase-order finance, factoring and asset-based lending.