Guide · 6 min read
Factoring, asset based lending or purchase order financing?
A practical way to match the financing structure to what your business actually needs to fund.
Most businesses that look for working capital are solving one of three problems. They are waiting to be paid for work already delivered. They need a flexible line that grows with the balance sheet. Or they need to pay a supplier before they can fill an order. Each problem has a structure designed for it.
Start with what you are financing
The right question is not which product is cheapest. It is which asset or transaction the financing is built around. Receivables, a pool of collateral and a specific customer order are different things, and the structures that finance them work differently.
Invoice factoring: when you are waiting to be paid
Factoring is the sale of receivables. You sell invoices owed by creditworthy customers and receive an advance against their value. When your customer pays, the balance is released to you, less the agreed fee. Because decisions weigh the credit of the customers you invoice, factoring often suits young or fast growing businesses whose own history is still short.
Factoring tends to fit businesses that sell to other businesses or to government on payment terms: transportation, staffing, business services, manufacturing and distribution among them.
Asset based lending: when you want a flexible line
An asset based loan is a revolving line of credit secured by collateral, usually receivables and inventory. Availability is measured by a borrowing base, which is the value of eligible collateral after advance rates are applied. As receivables are created and collected and inventory turns, availability moves with them.
Asset based lending suits businesses with a meaningful balance sheet that want to draw and repay as needs change. It involves periodic collateral reporting, and the credit agreement usually includes covenants.
Purchase order financing: when you need to pay a supplier first
Purchase order financing pays your supplier to produce or deliver finished goods against a confirmed order from a creditworthy customer. After delivery, you invoice your customer, and the invoice is paid or factored to settle the advance. It is built for resellers, distributors and importers who win orders larger than their current cash can support.
Combining structures
These structures often work together. A distributor might use purchase order financing to pay a supplier, then factor the resulting invoice. A manufacturer that starts with factoring may later move to an asset based line as its balance sheet grows. A good financing partner will talk through the path, not just the first transaction.
Questions to ask any financing partner
- Which of my customers, invoices or assets are eligible, and why?
- How are fees calculated, and when do they accrue?
- What reporting will I provide, and how often?
- How will my customers be notified, and who will they speak with?
- What happens if an invoice is paid late or disputed?
- How do I see the status of my account at any moment?
Clear answers to these questions, in writing, are the foundation of a financing relationship that works.