Purchase Order Financing and Manufacturing

Can purchase order financing help manufacturers? The truth is that the answer is "maybe".

As you can expect, many manufacturers don't like it when I say that. Many even take it the wrong way, thinking that financieers are against manufacturers.

Nothing could be further from the truth. It is all related to risk. Let me explain.

Lets say that you have a distributor or reseller who is buying widgets from a supplier and resells them to the government. Furthermore, the re-seller drop ships all items to the government directly.

The po financing company will happily underwrite the transaction. They will issue a letter of credit (or similar instrument) stating that the supplier will only be paid if they perform. If they provide defective materials - they don't get paid. As you can see, the financing company does not assume the manufacturing risk. This is critical.

Now. Lets say that to build a widget you need three suppliers. Suppliers one and two provide parts. Suppliers three provides assembly and delivery. Can this transaction be financed? Well, it is exponentially riskier. Why? Well, lets say that the po financing company issues letters of credit to pay all three suppliers.

Now lets say that any one of these things happen:
1. Supplier one ships defective parts. The product cannot be assembled.
2. Supplier 1 ships parts but supplier two goes bankrupt.
3. Suppliers 1 and 2 ship good parts but Supplier three fails to assemble the product

If either of these happen the financing company is in the hook to pay some of the suppliers. But - and this is critical - no product will be delivered to the customer. So the po financing has no way to recover the investment.

So, as you can see, financing companies are happy to take the financing risk of an order - but no the manufacturing risk.

And what do you do if you have multiple suppliers? There is a way to finance those. But, it's proprietary and only works on some special occasions :-)


Technorati tags: business financing business loan letter of credit purchase order financing

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