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Working Capital Loan vs. Purchase Order Financing: Which Business Loan Solution to Choose

When it comes to sustaining cash flow, many businesses-especially small businesses- find themselves grasping at straws.

Picture this scene: You’ve just launched your small business. It’s doing quite well. Demand is skyrocketing, which in turn provides an opportunity for you to generate more income. On the flip side, you still need to free up working capital to purchase raw materials, hire a skilled workforce, and so on. At some point, it feels like you’re stuck in the proverbial hard place and a rock.

So, how do you exit this dilemma? Whichever the situation, it is wise to explore business funding solutions that can facilitate increased efficiency, increased returns, and better performance. Simply look at the bigger picture. While it is possible to choose a loan option at first glance, flexible financing is the way to go.

Working Capital Loan and Purchase Order financing can both give your business the kind of capital flexibility it needs. However, they are two different financing options.

LQD Business Finance experts will help break down both the similarities and differences to help you make an informed financing decision.

Working Capital Loan

A working capital loan is a type of loan taken to fund a company’s daily operations. It is a flexible loan option for firms that need urgent cash to pay off recurring expenses. Small or medium-sized businesses settle things like debt payments, rents, or equipment financing using working capital loans. It’s the cash you need to keep your business afloat while you await new customers.

How it works

Working capital loans are a form of unsecured loans. They help you raise your working capital without having to risk personal or business assets.

Also, this loan is viable for businesses that experience cyclical sales or have high seasonality. It helps to cushion your company in periods of reduced business activity. For instance, manufacturers can secure working capital loans to cover operating expenses during a recession (the quiet period of the fourth quarter). Then, they repay the debt upon the turn of the busy season when the company no longer requires financing.

Business finance offered by working capital loans ranges between $1,000 and $50,000. Typically, the repayment period can be up to 36 months. For business owners who may like a considerable debt, they may have to put personal assets as leverage. The size of the loan depends on the firm’s creditworthiness and profile.

Purchase Order Financing

PO financing is an advance from a lender (financing institution) that reimburses your supplier for goods you are distributing or reselling to a consumer. In short, it is a loan type that helps small businesses to manage specific product orders.

A late or unfilled order can impact your business’ growth and reputation. Therefore, you need a funding alternative that can bridge this gap. Purchase order financing helps you to accumulate the right amount of working capital you require to deliver a product order and deliver it on time.

How it works

As a form of traditional factoring, purchase order financing provides a quick, short-term cash injection to a company when:

  • It is unable to pay for raw materials or goods that must fulfill a customer order.
  • The end-user is insisting on credit terms.
  • The customer is unwilling to pay an initial amount as a deposit.

It is the lender who advances the amount to the supplier. Upon receiving the goods, the customer pays the supplier directly. You will get your share of the deal once the supplier deducts their transaction fees.

But how do purchase order companies make money? It’s simple. They charge you a certain percentage of the funds they forward to your supplier. In exchange for paying upfront, you have to remit these fees to the PO lender.

Similarities Between Working Capital Loans and PO Financing

Many small businesses experience rapid growth, sometimes on a substantial scale. At this point, sales outweigh the incoming revenues. What follows is a lack of cash to cover for day-to-day operational needs or new orders. Working capital loans and PO financing can help your business to gain access to operational capital and stabilize its product order cycle.

Either of these business funding solutions can provide cash in a matter of days (less than 30 days in most cases). They are ideal if you’re a bad credit borrower or are looking to fund a startup. Some businesses which are eligible for this kind of loans include:

  • B2B (Business-to-Business)
  • B2G (Business-to-Government)

Often, working capital and PO financing provide access to large amounts of operational cash. The number of invoices or product orders that your company can generate will determine the size of your credit line.

The actual funding cost for these short-term solutions is similar too. For instance, the price of most loan packages at On Deck Capital- one of the world’s largest lending companies- is between 1% and 8% for the first month. You’ll incur additional costs after that.

Differences Between Working Capital Loans and PO Financing

Although these business financing solutions can serve similar purposes, they are inherently different. They are applicable under different circumstances. The significant distinctions between them include:

  1. The flexibility of Use (Loan Structure)

In a purchase order loan transaction, the money only serves to pay for the particular supply costs, which directly link to the purchase order. Due to its limited use, PO financing cannot help you build an inventory, unfortunately. Moreover, this solution is only best for re-sellers and not manufacturers.

On the other hand, working capital loan a flexible product. So you can use it to cover a variety of business expenses such as marketing, wages- name it. It can help you develop a long-term inventory, too.

  1. Loan Requirements

Qualifying for working capital loans is more straightforward than qualifying for PO financing. For one, you only deal with the lender alone- no third parties. It means that you can secure a loan in the shortest time possible. Mostly, the process may take less than two weeks.

Conversely, PO financing involves more parties. For approval to happen, the lender must confirm the creditworthiness of both the supplier and the end-user. So, loan eligibility depends on a lot more factors as opposed to working capital loans.

When to Choose Working Capital Loans vs. PO Financing

The ideal loan for your business will always depend on two principal factors:

  • What are you using the money for?
  • What kind of business do you have?

These two factors are correlated. Specific types of businesses, with particular needs, are ideally suited toward working capital loans or purchase order financing.

When to Choose Working Capital Loans

No matter how successful your small business is, there’ll come a time when extra cash flow will be a game-changer. This solution helps to infuse your business with immediate cash when:

  •  An exciting opportunity occurs

Every savvy business owner knows the value of grabbing once-in-a-lifetime opportunities. A working capital loan helps you to stay on top of situations like purchasing materials, upgrading your product line, and so forth.

  • You Need to Hire New Staff

At some point in your business, the benefits of hiring a skilled workforce will outweigh the cost. This loan helps you to make timely hiring decisions.

  • You Need to Upgrade or Replace Equipment

A working capital loan enables you to make necessary technology upgrades to keep up with the competitive business spectrum.

  • You Need To Stabilize Business Liquidity

Cyclic businesses may suffer a blow during the slow months. The company’s liquidity may also take a tumble when customers fail to pay on time. Therefore, a working capital helps you to streamline such inconveniences.

It’s easy to identify whether you are a fit for a working capital loan based on who your customers are. If you are working with individual clients or small businesses on small contracts, then working capital is the loan product for you. Industries that fit this description include consulting, trucking, and so forth.

When to Choose Purchase Order Financing

PO Financing is best when your business is experiencing:

  • Substantial cash outages
  • Rapid growth
  • Seasonal sales fluctuations

Thus, firms that suitably fall under this category would include contracting, construction, and the sort. Any company that needs to buy products upfront, then render the goods, before waiting to receive payment after some time, matches up with this type of debt.

While you are limited in how you can utilize your funds (for purchasing supply, that is), that constraint makes PO financing a safer loan option. The lender is somewhat convinced that you’re unlikely to use the loan irresponsibly. Thus, they will endorse it much quicker.

However, some charges can make this loan expensive — standard monthly fees are 6%-18%. But technically, the end-user pays upon receipt of the supplies. So, you don’t have to hold onto the cash for too long.

While we’ve mentioned several scenarios where PO financing might work, it is not in any way an all-inclusive list. A provider like On Deck Capital can help solve such situations.

Whether you’re thinking about a working capital loan or purchase order financing, you should first investigate the purpose that the loan will serve. It is also essential to keep in mind how the cash flow can help your business increase its competitive edge. Weigh the possibilities of increased capacity, improved stakeholder relationships, and overall organization growth before you put pen to paper on your loan contract

At LQD Business Finance, we can help you with your working capital needs. Our cutting-edge proprietary technology comes in handy to consolidate credit and expedite funding in less than 30 days. We offer flexible financing and a streamlined underwriting process with the help of a dedicated team of experts. Contact us and get the best financing solution for your situation today.

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