Financing Commodity Transactions with Purchase Order Financing

Every so often we get an inquiry from a company that wants to use purchase order financing to fund a commodities transaction. Unfortunately, I have never seen a single transaction succeed. At the surface, purchase order financing would seem like an ideal solution to finance a commodities transaction. But once you look at the details, transactions always fall through.

By the way, I am not saying that purchase order financing has never been used to finance a commodities transaction..... I am just saying that I have never seen one done and I have been at this for a decade. Here are some reasons why these transactions fail:

Gross Margins: Most PO financing companies will only work with transactions that have minimum gross margins of 20%. In fact, many prefer to see 30% gross margins. Having high margins offers some protection to the business financing company if there are any problems with the transaction. For example, if some product if damaged during transport, a high margin transaction will be less impacted than a low margin transaction.

Also - and this is very important - finance companies prefer to work with high margin transactions because purchase order financing is expensive. There are no two ways about it - PO funding costs more than conventional funding. Working with high margin transactions helps ensure that clients still have plenty of profit left after financing costs.

First Timers/Novices: The commodities field is full of startups that have high hopes but little transaction experience. Many of these companies have unrealistic expectations about their transactions. For example, many will claim they can sell oil or coffee at 30% gross margins if they could get the funding. Unfortunately, that is not believable. Commodities tend to sell for single digit margins. PO financing companies prefer to steer clear of these types of transactions.

Questionable Suppliers: Many novices also tend to work with what I will call "questionable suppliers" that are located in far flung places of the world. Usually these suppliers offer products at "very cheap prices" but also have questionable demands. For example, this type of supplier may be able to sell product at a substantial discount but demands prepayment of the full amount by wire transfer and will not accept a third party product inspection. Many novices tend to want to work with these suppliers ,which again scares of funding companies.

MT1099 (Proof of Funds): Most po financing companies will not get involved in a transaction where the supplier demands proof of funds (e.g. MT1099). Most purchase order finance companies will not provide an MT099 to your supplier. Contrary to popular belief, MT1099's can be misused so many po financing companies steer clear from them. Most PO financing companies will be happy to pay your supplier with a letter of credit that is contingent on an inspection from a third party company. If you think about it, showing a letter of credit should be proof enough that funds are there.

On a similar subject, factoring won't be able to help many commodity trading companies either for the exact same reasons.



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