Purchase Order Finance:Accessing Capital for Small Business

Johannesburg; June 27, 2012

SME Access to Finance

SMEs are key to economic growth and job creation. But they often face obstacles in accessing the financing they need to grow their businesses, including:

– Financial Institutions (FIs) view SMEs as more risky, especially rural and agricultural businesses

– FIs view SME lending as more costly– FIs often require urban real estate collateral and historical financial statements in

credit assessment– SME lending, when available at all, is often mismatched in purpose, type, tenor and

required collateral– Ironically, once SMEs obtain finance from FIs, further growth is often impeded,

putting them in a financial straightjacket

To dramatically increase employment and decrease poverty, we need innovative and effective ways to support SMEs and their growth

• POF is a way to purchase finished goods or raw materials that will be turned into products that are resold and shipped, usually within a relatively short time frame.

• A third party will issue a Letter of Credit to your supplier, which serves as an advance on the funds you have been promised in the form of your Purchase Order.

• Now you have the capital to fulfill your big order. • What Purchase Order Financing does NOT do is give you any extra money for

other operating costs. • You might receive somewhere between 45 and 65 percent of your expected

invoice amount. And the financier earns a fee for its service.• For new or established companies, Purchase Order Financing can help you

accept larger orders, build your reputation, and grow your business. • Is there any better feeling as a business owner?

What is Purchase Order Finance (POF)

Why Use Purchase Order Finance (POF)

• Short term working capital finance to fill orders• Pre-shipment and pre-export• Transaction linked (not general line of credit or loan) & self-

liquidating• Loan (advance) amounts are versatile based on the size of the order

and on the size of the company.• Tenor of 15 – 365 days• Extremely efficient instrument to create sales and jobs• Effective throughout the value chain from input suppliers all the way

to final customer.

1. Smaller start-ups with sales orders coming in but without necessary capital to fulfill

2. Larger, more established businesses with unusually large orders or for a big new customer.

Don’t automatically say “no” the next time an order comes in that would normally be too big to handle. Consider purchase order financing - it could be the bridge to a bigger and more profitable business.

What kinds of businesses use PO financing?

• The key driver is that approval is based on the credit, track record and trustworthiness of your customer.

• If anything falls through, the bank takes the hit. So be sure that your trust in your customer is well placed.

Key driving issues for successful purchase order financing?

Purchase Order Finance – Use of Funds

• Inputs

• Raw materials

• Packaging & graphics

• Components

• Testing & inspection

• Shipping costs

• Finished/trade/commodity goods for resale

• Insurance costs

• Utilities

• Direct labor for production of goods or delivery of service

Purchase Order Finance Structure

Purchase Order Finance

From a Bankers Perspective

• Innovatively finance SMEs by filling gaps in the market• Increase sales and profitability• Create new employment, maintain employment and

increase incomes• Provide opportunities to disadvantaged populations• Increase local production and manufacturing• Ability to support all sectors/value chains and all regions• Improve quality, competitiveness and sustainability

Objectives of the Product

Purchase Order Finance – Types of Collateral

POF loans can be secured utilizing some of the following collateral:– Purchase Order or Contract for product or services– Working capital assets (inventory, accounts receivable, etc.)– Letters of Credit– Cross checks/company blank checks/post-dated checks– Bills of exchange– Bank guarantees– Debentures– Promissory note– Insurance (credit, export, etc.)– Personal and corporate guarantees– Fixed assets

Purchase Order Finance – Risk Mitigation

• Direct payment to borrower’s suppliers• Assignment of PO/contract/receivable• Bank account with dual signature requirement into which payments on

invoices are received (trust account, internet banking)• Alternative forms of collateral/security (previous slide)• Interim interest payments• Interim principal payments• Value chain approach to due diligence, client screening, deal sourcing,

risk mitigation• Relationship management• Cross selling of products and services• Diversification

Thank You

www.fsp.org.za