KTC White Paper – How Purchase Order Finance can help fulfill customer orders

Sunday, May 1, 2011

King Trade Capital

How Purchase Order Finance can help fulfill customer orders

By Bryan Ballowe, Vice President and Chief Operating Officer

How Purchase Order Finance can help fulfill customer orders

Most companies find that there’s a catch-22 to financing sales growth. On one hand, the goal of every business is to increase sales to improve their bottom line, but on the other hand, once a company lands a large profitable order many times there is an initial outlay of cash required to fulfill it. Sales growth tends to starve a company of internally generated cash flow, especially in situations where supplier credit doesn’t exist and manufacturers must be paid up front. That coupled with the fact that many companies extend payment terms to valued customers to win business results in a significant cash flow gap. If a company’s balance sheet doesn’t support a traditional loan, or supplier credit doesn’t exist, how can a company take advantage of sales growth opportunities? Purchase order finance may be the ideal solution to solve such a dilemma.

It’s important to detail some of the funding options available to companies as well as point out some of their limitations:

• Bank Financing. Bank financing is the cheapest and most recognizable form of financing to most. Traditional lenders evaluate past performance of the company including the balance sheet, income statement, and free cash flow. Traditional lenders also focus on collateral such as accounts receivable, real estate, equipment and marketable securities to name a few. This form of financing is the least expensive since the criteria is more stringent and requires the lender to be well collateralized at all times. The old adage that a bank will provide financing only when a company can prove they don’t need it holds true in this instance. What about those companies that don’t have a balance sheet to support a traditional loan? Many young companies are unable to pledge the necessary collateral to warrant a relationship with a bank. Furthermore, if a company is growing, past performance is not an accurate indicator of future performance and the loan amount a bank approves may not support the existing spike in sales that the company is so desperately trying to finance. The time to finalize a relationship with a bank can oftentimes take months and requires extensive field and collateral audits. Companies that are trying to finance growth can’t afford to wait that long – they need financing immediately.

• Asset Based Lending and/or Factoring. In many instances, this can be a very viable solution to fast growing companies. Asset based lenders lend against a pool of eligible accounts receivable and/or liquidation values of inventory. Similarly, factors purchase specific accounts receivable to provide liquidity to companies. If goods have already been delivered and/or services have been rendered and an invoice has been generated, an asset based lender or factor can provide much needed liquidity to help with a company’s cash flow needs. What happens if a company can’t get goods produced and shipped? It’s the “chicken or the egg” dilemma. In this instance an asset based lender or factor can’t help.

• Equity/Mezzanine/Tranche B Funding Alternatives. This type of funding solution may provide significant flexibility, however can be difficult to find and ultimately can be the most expensive. In order to obtain equity financing, a company must give up permanent ownership and significant operational control. Under most instances, trying to find equity takes a significant amount of time. Like equity, mezzanine debt gives the lender the ability to convert to an ownership position and can be very time consuming to find. Tranche B lenders look for enterprise value to support a “second lien” financing and require certain rights that may ultimately give them control against an existing senior lender in the event of a default. Many times existing senior lenders will not allow a company to bring on a Tranche B lender. These alternatives are better suited for longer term needs and are not really a viable solution to solve a short term spike in sales.

• Purchase Order Finance. This type of financing provides a solution to fulfill a sudden spike in sales and focuses on the direct costs needed to fulfill those orders such as cost of goods, direct labor, duty, freight and warehousing needs. Unlike the other types of financing mentioned above that focus on assets, and/or past financial performance, Purchase Order finance focuses on specific orders and what is required to fulfill those orders. Purchase Order financing does not require the company to give up ownership. It is not limited by the amount of the company’s existing accounts receivable and is an excellent solution to secure payment to a supplier that requires advance payment. Purchase Order finance does not involve a lengthy approval process and can be put in place within a matter of days under many circumstances. Purchase Order finance can also complement the position of an existing senior lender since Purchase Order financing is transactional. The orders and specific collateral supporting the Purchase Order financing can be carved out of the existing lender’s collateral.

Requirements of Purchase Order financing

While every Purchase Order financing opportunity is unique, certain requirements must exist if a company wants to work with a Purchase Order financing company. The most important requirements include the following:

• Firm, verifiable purchase orders in hand. A customer looking for Purchase Order financing must have a firm, valid order in hand. The purchase order must be verifiable with the customer issuing the order and can not reflect a guaranteed or consignment sale where payment is predicated on sale through.
• Credit worthy end customer. The purchase order must be issued by a creditworthy end customer.
• The company must be able to demonstrate that they are able to fulfill the purchase order. It’s not enough just to have a purchase order in hand from a creditworthy end customer. The company looking for Purchase Order financing must be able to demonstrate the ability to perform in order to fulfill that order. Some of the key components that a Purchase Order financing company looks for are experience, strong suppliers, quality control, and the ability to handle the logistics to fulfill deliveries on time.
• Priority interest in transaction specific collateral. In the event the company looking for Purchase Order financing help has a relationship with an existing lender, the existing lender will be asked to agree to subordinate its interests in the specific assets related to the PO financing until such time as the Purchase Order financing company is paid in full.
• Acceptable repayment terms. The Purchase Order financing company must either be paid directly from the end customer or from an advance on the resulting accounts receivable by a bank, asset based lender or factor.

How Purchase Order financing can help

When a company lands a large order or experiences a seasonal spike in orders that can’t be financed by its existing working capital, its lender or through supplier credit, Purchase Order financing is a viable solution to a short term funding need. The typical Purchase Order finance process is illustrated below:

Step 1

Company wins a large order or realizes a large seasonal spike in business

Step 2

A Purchase Order finance company is brought in and secures payment directly to specific vendors by issuing letters of credit and/or making cash payment.

Step 3

Goods are produced and shipped to the end customer(s). At that time a valid invoice is generated.

Step 4

Usually, a senior lender will advance on the resulting invoice and remit available proceeds to the Purchase Order finance company first until paid in full. Under certain situations, the end customer will make payment directly to the Purchase Order finance company.

Step 5

Once the Purchase Order finance company is paid in full, the net proceeds are remitted to the company.

The following scenarios further illustrate how Purchase Order financing can solve a short term financing need:

• A regional asset based lender has a customer that produces skin care products. The company has been in business for over 10 years and is very seasonal. They manufacture the product in their facility. Over the past two seasons, sales have been down and the customer has required the asset based lender to provide an over-advance facility to cover the working capital needs of the company through the slow times of the year. The customer suddenly realizes a large spike in business, however is in an over-advance position with its lender and also owes its suppliers money from previous shipments. The company needs financing to buy raw material and pay for direct labor to fulfill the spike in orders. Purchase order financing can be a solution to procure raw material and pay for direct labor in order to fulfill orders. Additionally, Purchase Order financing can help the company’s existing lender get out of its over-advance position.

• A factor has a potential client that imports various home accessories. The client just filed for Chapter 11 bankruptcy protection, however has experienced significant orders and requires financing to maintain its valued customers and fulfill deliveries critical to its reorganization plan. The client’s existing bank is pushing for liquidation since it is not willing to provide additional financing. With the trustee’s approval and super priority interest granted by the bankruptcy court, Purchase Order financing can provide the critical component necessary for the survival of the client.

• A company has received a large order from an overseas customer to deliver excavating equipment. The order is backed by a documentary bank letter of credit as a form of repayment. The company’s bank will not lend against the letter of credit since it is not traditional collateral and the funding need is larger than what the company’s balance sheet can support. Purchase Order financing can provide a solution by financing the purchase of equipment directly from the supplier and taking an assignment of proceeds under the bank letter of credit as direct repayment.

The Benefits of Purchase Order financing

• Provide the financing necessary to fulfill a profitable orders quickly without giving up equity.
• Enable the client to win more business and not be hindered by the lack of working capital and/or supplier credit.
• Help the client build its balance sheet through profitable sales.
• Help strengthen the client’s relationship with its suppliers by securing payment prior to goods being produced and shipped while helping to build future supplier credit.
• Help the client strengthen its existing relationship with its lender by creating more collateral and strengthen its financial condition.
• Help structure secure transactions by analyzing, executing and minimizing trade risks that exist in domestic and international trade cycles. A Purchase Order finance company has expertise in areas such as documentary letters of credit and payment against presentation of documents. This helps create a more disciplined approach to dealing with both domestic and international suppliers.
• Help banks, asset based lenders, and/or factors keep a valued client or win a client without taking on additional risk associated with over advances.

About King Trade Capital

King Trade Capital is the largest and longest-operating independent Purchase Order financing company in the country. Our team of experts has well in excess of 50 years of combined Purchase Order and/or commercial banking experience. Our Purchase Order financing provides a solution for importers, exporters, and domestic manufacturers by financing up to 100% of the cost of pre-sold inventory through letters of credit and cash payment. For more information, please visit us at www.kingtradecapital.com or call 214-368-5100.