You have probably heard that purchase order financing companies usually get involved in transactions that have a minimum average gross margin of 20% (this number fluctuates a little bit).
Why is this the case?
The answer is simple. The purchase order finance company covers the Cost of Goods Sold (COGS) of the client. The Gross Margin ( which is the the (Sale - Cogs)/ Sale) must be able to cover:
1. The business owner's profit
2. The purchase order financing fee
3. Any incidentals such as breakage, disputes, delays, etc.
The biggest unknown of the three items is "incidentals". Entrepreneurs and business owners can sometimes be excessively optimistic about the capabilities of their suppliers. The cold hard reality is that many times, things go wrong. Sometimes, they go spectacularly wrong. Working with transactions that have an ample gross margin protects both clients and purchase order financing companies by increasing the chances that any incidentals will be covered out of the gross margin.
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