Transfin.
HomeNewsGuidesReadsPodcastsTRANSFIN. EOD
  1. Guides
  2. Advice

How to Fix Working Capital Woes of the SME: Purchase Order Financing

A Technology-driven SME Financing Platform
May 23, 2018 6:42 AM 4 min read
Editorial

Editorial Comment: Purchase Order Financing is a useful funding option for growing businesses and Small & Medium Enterprises (SMEs), typically seeking to fulfil a large customer order which requires a significant upfront payment. Cash constraints often cause ventures to forego large orders. Purchase Order Financing avoids such a situation by making the payment on behalf of the SME or by opening a line of requisite credit. This article explores the underlying mechanics of this specialist form of funding.

 

Purchase Order Financing is a relatively new, raw-material procurement procedure wherein a third party (the financer) pays the supplier for the purchase order. The financer is usually a Non-Banking Financial Company (NBFC) that makes the payment on behalf of the SME in accordance to the terms of the credit line approved. This payment method is quite new but comes with a multitude of benefits for the SMEs, rapidly making it an industry norm. 

How to Fix Working Capital Woes of the SME: Purchase Order Financing

Why Is Purchase Order Financing A Game Changer?

 

The biggest challenge for a SME is the management of its working capital cycle. With the rate of repayment lagging behind the rate at which a payment becomes due, delayed settlements pile up, pushing SMEs to a compromising position. This, in turn, hampers their cash-flow cycle for raw-material procurement.

 

A lot of SMEs are owned and managed by first-time entrepreneurs. With limited financial resources at their disposal, these businesses are often bootstrapped. Due to a lack of expertise and experience, they typically end up crossing the budgeted threshold of expenses. This can unsettle the purchase cycle and creditor turnover ratio and lead to an accelerated accumulation of outstanding expenses.

 

The limited working capital availability not only impacts one's access to raw material, but also affects day to day operational requirements (eg. manpower costs). Furthermore SMEs find it difficult to procure loans from banks without adequate collateral, often found wanting.

 

NBFCs therefore have come up with an innovative payment mode which is designed to provide unsecured loans and credit lines to meet such short-term capital requirements without any security. 

 

Features of Purchase Order Financing

 

Purchase Order Financing is designed to provide short-term financing hassle free and is tailored to overcome the shortcomings of bank loans. Features are as follows:

  • Accessibility – Major players such as OfBusiness are present both online and offline. Most processes are on automated via digital platforms leading to quick verification of documents and disbursals.
  • Quick Disbursement – Three to five days is the average time taken to approve unsecured business loans post submission of the required documents by NBFCs. This swiftness in disbursals ensures that any and all short-term capital requirements that might arise are fulfilled before any payments become overdue.
  • Collateral-free – SMEs often find it difficult to secure a collateral for a short-term funding requirement. Purchase Order Financing in contrast requires no collateral.
  • Payment of interest – NBFCs offer working capital up to INR2 crores for Purchase Order Financing. Credit lines offered by NBFCs require payment of interest only on the amount used and for the usage period only.
How to Fix Working Capital Woes of the SME: Purchase Order Financing
Source: By Fahad Faisal [CC BY-SA 4.0 (https://creativecommons.org/licenses/by-sa/4.0)], from Wikimedia Commons

Benefits Of Purchase Order Financing

 

  • Better material costs – With availability of ready cash, SMEs gain more negotiating power over suppliers to secure better raw-materials in accordance to their requirements.
  • Savings on interest payouts – Interest-rate charged amounts to c. 1.4-1.6% per month on the amount used and for duration deployed. As compared to traditional lenders, this rate of interest is 1% lower. Thus, SMEs using Purchase Order Financing for bulk raw-material procurement can save on interest up to 3% for over a period of 90 days.
  • A wide range of products – NBFCs also help SMEs procure bulk raw-material at competitive prices from their strategic partners. This helps SMEs procure quality raw material for their operations and get it delivered to any location with ease. Different procurement organizations – offer bulk raw-material purchasing for TMT, steel bars, polymer, textile, cement etc.

 

Purchase Order Financing is a strategic solution for SMEs to ensure uninterrupted operations and have a better organizational relation with the suppliers. This idea has evolved over the past few years and is likely to have a steep growth curve with immense opportunities being offered to the SMEs. From savings on interest to better procurement, purchase order financing offers it all-in-one.