Two types of alternative business financing that often get confused with one another are Accounts Receivable Financing and Purchase Order Financing. It’s understandable that they sometimes get confused, however, they are two very different types of alternative business financing that serve two very different purposes.
Accounts Receivable Financing is used when you have outstanding invoices on your aging report and want to access that cash now instead of waiting to be paid at a later date. NOTE: To qualify for Accounts Receivable Financing, your product or service must have been delivered and invoiced; otherwise there are no Accounts Receivable invoices to use as collateral.
The two types of Accounts Receivable Financing most commonly used are Asset Based Lending and Factoring:
- Asset Based Lending – You can get traditional bank financing or alternative business financing in the form of asset based lending. If you qualify for bank financing, go that route first because the cost of capital will always be less than non-traditional asset based lending. You receive a line of credit from a bank or non-bank lender and use your accounts receivable invoices as collateral for the line. Each institution has different underwriting standards; however, the important thing to remember is that the strength of your company will still play a role in getting approved. It will be not be possible to get bank financing if your business is losing money because banks are very conservative…and rightly so; they’re not making much money on your line compared to non-traditional lenders. These non-traditional lenders will still have to qualify your company in the underwriting process (although less stringent) and have certain covenants tied to the line in order for it to stay open.
- Factoring – This is a form of financing where a 3rd party purchases your accounts receivable invoices at a discount so you can receive working capital today instead of having to wait 30, 60 or 90 days to be paid. Factoring is more flexible that asset based lending in the sense that you’re qualified based on the strength of your clients, not your financial strength.
Purchase Order Financing, also known as PO Financing, is used when capital is needed to fulfill an order after receiving a PO. Smaller companies that start to receive larger orders can turn to this type of alternative financing to help sustain growth. PO Financing only makes sense when profit margins are large enough to offset the cost of capital. It can be costly; however, it’s still cheaper than equity.