Purchase Order Finance

Last updated on 22 Aug 2024

14 Sep 2016 . 1 min read

The above Supply Chain Finance techniques have been defined by the Global Supply Chain Finance Forum (BAFT, EBA, FCI, ICC and ITFA)

Mark Abrams

Mark heads up the trade finance offering at TFG where his team focuses on bringing in alternative structured finance to international trading companies.

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What is Purchase Order Finance?

Purchase order finance is commonly used for trading businesses that buy and sell; having suppliers and end buyers. Financing is on the basis of purchase orders that allow a shot of finance into a growing company – this type of facility is sometimes used or not known about by many companies and is at many times an alternative to investment. It also provides huge advantages when negotiating with suppliers and end buyers – gaining credibility within the transaction chain.

Purchase order finance usually goes hand in hand with invoice finance, as purchase order financier is paid back by an invoice finance lender when goods are received by the customer.

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FAQ

How does the transaction cycle work and what documents are required?

Using a toy manufacturer as an example – the buyer will come forward and raise a purchase order for goods. There will be a corresponding purchase from the supplier that will be paid by the funder. This can be done in various ways such as deposit and later full payment, cash against document or cash against a Letter of Credit. Goods are usually sent directly to the end customer and when the product arrives with the customer; an invoice is then raised. A funder will usually fund a percentage of this invoice that is raised to the end customer and will use the funds to pay down the trade finance line; which is usually a higher cost than the invoice finance line.

How does purchase order finance work?

Purchase order finance is seen to be a number of things. There will be a commitment from a purchaser for goods and the question falls on how the supplier is paid. There could be the requirement for a deposit to be paid pre-shipment e.g. 30% on order and 70% upon shipment, there may be an agreement that all funds are paid against documents e.g. loading and title docs or it could be that there is an agreement to release goods against a letter of credit.

Why would you use purchase order finance?

The aim of having a purchase order and an invoice finance facility in place is that a sustainable debt structure leaves the company to invest in cash flows, R and D and other non-trade related but cash intensive elements. This will permit expansion based on purchase orders and corresponding invoices with funding to match these requirements. This is unlike lending types such as bridging or other secured financing types whereby there will need to be an equity owned asset and there is funding against an element of that asset. Thus growth can be sustainable and unhampered. It also allows this growth to far exceed the cash values that the company have in their accounts and allows smaller companies to play at an elevated level.

Finance in relation to purchase orders is usually short term – being 30-90 days and on average is usually 45 days per trade. It will usually be the most expensive element of a trade so the aim is to keep it short and it is usually paid down by a corresponding invoice finance line.

It is important to look at the many trade finance solutions that are available along with the business need and sector. We do this and work together with you to try and create the most suitable solution.

What is Purchase Order and how are they used?

An electronic purchase order document is a digital document that initiates a transaction, defining prices, quantities and delivery dates in accordance with pre-negotiated contractual conditions, between a buyer and a seller. It is used by a buyer to request goods, items or services from a supplier.

Sourced from ICC DSI

What is the legal framework governing purchase orders?

In the context of electronic invoicing, as per the European Union (EU) directive, the purchase order can serve as one of the business controls that confirm the authenticity of an invoice. In the public sector, particularly for tender-related matters, the purchase order must be publicly disclosed. In Italy, specifically within public healthcare procurement, the electronic order is obligatory and is processed through a public platform known as NSO (Nodo Smistamento Ordini). Furthermore, the purchase order can hold legal significance akin to a contractual agreement.

Sourced from ICC DSI

What are the key digital standards in purchase orders?

UN/CEFACT (United Nations Centre for Trade Facilitation and Electronic Business):

UN/CEFACT has been at the forefront of developing international data standards and business processes for supply chain facilitation from paper trade documents (United Nations Layout Key—UNLK) to UN/EDIFACT (United Nations Electronic Data Interchange for Administrations, Commerce, and Transport). UN/CEFACT also introduced Reference Data Models (RDM) based on the UN/CEFACT Core Component Library (UN/CCL). These standards cover various facets of international trade, including procurement, transport, border clearance, and more.

UBL Format (Universal Business Language):

ISO/IEC 19845:2015 specifies the Universal Business Language (UBL), offering a generic XML interchange format for business documents. UBL provides a suite of structured business objects and associated semantics expressed as reusable data components and common business documents.

GS1 EDI (Electronic Data Interchange):

GS1 EDI provides global standards for electronic business messaging which encompasses master data alignment, order processing, delivery, financial settlement, transport, and warehouse management. Key business partners covered include retailers, manufacturers, healthcare operators, and logistic service providers.

ANSI X.12 850:

The American National Standard Institute (ANSI) oversees standards and conformity assessment in the United States. ANSI X.12 is the EDI standard, with “850” representing the Order message.

Sourced from ICC DSI