Invoice Factoring vs. Purchase Order Financing: When to Use Each
Invoice factoring and purchase order financing are complementary tools. Here's how each works and when to use one versus the other.
Key Takeaways
- ✓Invoice factoring funds after work is complete; PO financing funds before production starts.
- ✓PO financing is typically more expensive (3%–6% per month) than factoring.
- ✓Many businesses need both: PO financing for production, factoring for the resulting invoice.
- ✓PO financing requires a verified purchase order from a creditworthy buyer.
- ✓Some lenders offer combined PO and factoring facilities for a seamless solution.
The Core Difference: Before vs. After
The fundamental difference between purchase order financing and invoice factoring comes down to timing relative to production:
Purchase order (PO) financing: You have a purchase order from a customer but haven't produced the goods yet. You need capital to buy raw materials, pay suppliers, or fund manufacturing. PO financing provides this pre-production capital.
Invoice factoring: Work is done. Goods are delivered. Invoice is issued. Now you need to convert that invoice to cash without waiting 30–60 days. Factoring provides post-production capital.
They solve different problems at different points in the business cycle.
When You Need PO Financing
PO financing fits situations where:
- You've won a large purchase order but don't have inventory or raw materials to fill it
- Your supplier requires upfront payment and your customer won't pay until delivery
- Your gross margin is high enough to absorb PO financing costs (typically 3%–6% per month)
- The buyer is creditworthy enough that the PO itself is reliable collateral
Example: A clothing brand receives a $300,000 PO from Target. Fabric and manufacturing in Vietnam cost $150,000 and must be paid upfront. PO financing covers the $150,000 manufacturing cost. When Target receives and accepts the goods, an invoice is issued—which can then be factored for the remaining cash flow.
Using Both Together
Many businesses—particularly distributors and manufacturers—use PO financing and invoice factoring in tandem:
1. Receive purchase order from customer
2. PO financing funds raw materials and production
3. Goods are produced and delivered
4. Invoice is issued and factored
5. Factoring advance repays the PO financing and covers remaining costs
6. Customer pays factor; reserve released to you
Some lenders offer combined facilities that automatically transition from PO financing to invoice factoring as milestones are hit. This eliminates the need to coordinate two separate lenders.
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