Purchase order (PO) Financing and invoice factoring are two financial strategies that businesses can use to purchase inventory or materials and accelerate the conversion of accounts receivable into cash.  With so many financial products out there, it is easy for people to be confused about these financing tools, how they work, and their advantages. 

The two strategies are closely related but they are distinct.  Helping business owners understand the difference will allow them to be paired with the right financial strategy and will also make them more comfortable using these financial tools.

What PO Financing and Invoice Factoring Are Used For

PO financing (aka purchase order funding) and invoice factoring are both used to address cash flow issues and provide working capital, but they are utilized at different stages in a transaction cycle.

PO financing is used to purchase inventory, materials, or other resources related to specific purchase orders or contracts.  It provides funding to a business’s vendors or suppliers so they may fulfill an order or get started/ complete a project.

Frequently, small and medium-sized businesses are unable to obtain credit from suppliers or a loan from a bank to purchase inventory or materials due to varying circumstances.  It is important to note that in certain instances where the supplier is located outside the U.S., a letter of credit is usually required.  PO financing provides businesses with the ability to fulfill orders as well as perform work BEFORE they’ve invoiced and received payment for the invoices.  In essence, it’s an advance against the funds a business expects to receive once their customer’s invoice is paid and is meant to cover the cost of goods sold.

Invoice factoring, on the other hand, is a financial tool that businesses use to accelerate cash flow by selling their unpaid invoices for a completed order or project to a factor company at a discount. Businesses receive cash immediately for their unpaid invoices instead of waiting for their customers to pay.  This funding can then be used for things such as payroll, operating expenses, growing the business, moving on to the next contract or project, etc.

How PO Financing Works

Invoice factoring can be used by itself to accelerate cash flow without also using PO financing. However, when PO financing is used, invoice factoring is also used to complete the financing transaction.

The steps in a PO financing transaction include: 

• Client receives an order or enters into a contract with their customer.
• Client forwards the purchase order to their supplier and the supplier provides an estimate of the cost to fill the purchase order.  In cases when the client enters into a contract for a service or project, the client obtains estimates for materials or other resources from the respective vendors.
• Based upon the need for funding, the client enters into an agreement with a factor company to fund the purchase of inventory, materials, or other resources for the specific purchase order or contract.
• The factor pays the supplier/ vendor through cash proceeds (or with a letter of credit if the supplier/ vendor is located outside of the U.S.), and the client takes delivery of the inventory or materials.  The proceeds may cover up to 100% of the cost however the client may have to pay out of pocket to make up any difference.
• Client completes and ships the customer order, or performs the work contracted for and invoices the customer.
• Client assigns the invoice for the completed order or services to the factor. The factor purchases the invoice once the validity of the receivable is verified and makes a partial advance on it first deducting the supplier/vendor payment and fees.
• Once the related balance under the PO financing facility is retired, the client is then eligible to receive the remainder of the factor advance amount depending on the terms of the factoring agreement.
• Client’s customer will remit payment for the invoice directly to the factor.
• The factor receives payment on the invoice from the client’s customer and deducts the factoring advance as well as factoring fees, and remits the balance to the client.

How Invoice Factoring Works

The steps in an invoice factoring transaction include:

• Client enters into an agreement with a factor company.
• Client completes and ships the customer order, or performs the work contracted for and invoices the customer.
• Client assigns the invoice for the completed order or service to the factor. The factor purchases the invoice once the validity of the receivable is verified and makes an advance to the client depending on the terms of the factoring agreement.
• Client’s customer will remit payment for the invoice directly to the factor.
• The factor receives payment on the invoice from the client’s customer, deducts the factoring advance amount and factoring fees, and remits the balance to the client.

Advantages of PO Financing

PO financing allows business owners to increase the necessary working capital required to boost sales, increase product or service offerings, and allows the business to gain the edge over the competition.  

PO financing is more accessible to obtain than a bank loan and may be easier to qualify. The credit underwriting decision is based on the financial strength of the client’s customer, unlike a bank that uses the business’s credit profile regardless of the income and cash flow that will result from fulfilling a firm purchase order or contract.

This is particularly important in light of the Federal Reserve’s change to a tight monetary policy, and the possibility that it might induce a recession. In this environment, bank credit requirements are tightened. Banks favor large customers and have a tendency to reduce credit exposure to small and medium-size customers.

PO financing may sometimes cover up to 100% of the supplies, inventory, or resources needed to get started/ complete a project or an order.  All the while without using credit available under existing lines of credit. It also enables clients to pursue business opportunities, which they might not otherwise be able to do because of insufficient working capital financing, and it can also be a stepping stone to developing a relationship with a supplier that leads to open-account terms.

Advantages of Invoice Factoring

Invoice factoring helps to accelerate cash flow by converting accounts receivable to immediate cash. Clients will not have to wait 60+ days for their customers to pay an invoice. Having access to those funds increases cash flow and reduces the need to draw down on availability under existing lines of credit.

An invoice factoring facility is also easier to obtain than a bank loan, and the credit decision is based on the financial strength of the client’s customer, not the client.  Invoice factoring facilities are more flexible to use than bank loans. In addition, they can be custom-tailored to fit within a business model.

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While PO financing and invoice factoring are both designed to provide solutions to a business’s working capital needs, the key points to consider are the timing of when the funds are needed in the transaction cycle and the use of funds.  Understanding the differences will help pair the right financial strategy with the right type of business. 

The surge in inflation driven by record fiscal stimulus, pandemic lockdowns and restrictions, supply-chain disruptions, and the war in Ukraine has created a major challenge for business owners in the construction industry in bidding on new projects and maintaining sufficient cash flow.

Many of the commodities used in construction are subject to changes based on third-party events outside of your span of control such as changes in world market prices and geopolitical events. Despite the Fed’s tighter monetary policy, inflation appears to have become embedded in the economy and may continue to persist at elevated levels for some time.

Construction Cost Increases

The following table lists some examples of changes in the Producer Price Index (PPI) reported by the Bureau of Labor Statistics for key materials and other inputs used in construction.

Along with these costs, labor and wage costs have increased in response to inflation and worker shortages. Average hourly earnings in construction rose 5.8% from February 2021 to January 2022 for hourly tradesmen. The average for similar workers in the overall private sector jumped 6.9%. Unfortunately, these wage increases have not kept pace with inflation and further wage increases may be required to keep your skilled staff employed with your company. 

Overhead costs have also experienced inflationary increases. Personnel costs, rents, and other administrative costs have surged. Unlike construction materials costs, which rise and fall with demand and supply, overhead cost increases tend to become ingrained in a company’s cost structure.

Impact of Inflation on Profit Margins and Cash Flow

Inflation in construction costs has squeezed contractor profit margins significantly. The PPI for input costs rose 1.8% for the 12 months to September 2020, matching the 1.8% increase in PPI for bid prices. But the 19.6% increase in PPI for input costs for the 12 months ended December 2021 far outpaced the 12.5% increase in the PPI for bid prices. 

Contractors must take steps to factor inflation into bid prices, improve the accuracy of their bids, and ensure the project retains profitability.  Inflation erodes a project’s profit margin and if left unchecked can create serious cash flow issues. 

The risk of inflation increases with the size, length, and complexity of a project. Size increases the potential magnitude of impacts from inflation. The length provides the opportunity for inflation to occur and reduces the reliability of estimates. Complexity increases the number of variables subject to potential change. 

Whether you’re a general contractor, subcontractor, or in another segment of the construction industry, the following tips will help you develop your project bids in an inflationary environment. 

Tips to Improve Bid Development Process

Review the way your company develops bids to improve accuracy. 

• Checklists – Use checklists to ensure all important items are included in the bid.
• Carefully review plans – Check takeoffs and measurements to improve accuracy.
• Attend pre-bid meetings and site visits – Review project requirements and get clarification when needed.
• Technology – Use software to improve estimates and accuracy of bids.
• Subcontractors – Review past performance, bid details, and pricing. The lowest bid isn’t always the best if the job is late or performed unsatisfactorily.
• Labor costs and practices – Review local labor costs and practices. If union labor is used, review work rules and how they will impact productivity and costs.
• Financing costs – Work the cost of financing, or factoring services, into the price to your client.
• Bid the right projects – Bid on the projects that fit your company’s strengths.
• Expiration date – The bid should have an expiration date so you have the opportunity to rebid if the bid validity date passes to account for the higher cost of goods.

Implement Project Management Tactics

If your bid is accepted there are many project management tactics that can be used to mitigate the effects of inflation.

• Time material purchases – Careful timing of purchases can help to contain material costs, especially when seasonality is a factor.
• Monitor costs – Perform regular variance analysis to determine which costs are trending upward.
• Hedge commodity prices – Use futures contracts to lock in prices of key commodities.
• Inventory – Stock up on inventory to protect your business from future price increases if you have the cash to do so.
• Discounts for early payment – Manage your cash flow to regularly take advantage of early-pay discounts offered by your suppliers and vendors.  These discounts can really add up.  
• Critical suppliers and vendors – Identify critical suppliers and vendors then negotiate.  Some may be willing to offer better pricing to maintain a valuable customer. 
• Best practices – Use best practices such as Target Value Delivery to empower your team to manage the project to bid targets.
• Technology – Incorporate technology to facilitate project management.
• Performance and quality control – Complete the project on time and maintain a high level of quality control. Your customer may be more open to accepting future bids with more robust profit margins if they know they can count on you and will receive quality results.  

Include Inflation Terms in Contract Language

Construction cost inflation has not exceeded 5% for over three decades so many contractors do not have experience in an inflationary environment. Adding a few percentage points to bids for inflation won’t protect you sufficiently in this type of environment either.

There are many different approaches to mitigate inflation risk in bids.

• Time and material – Charging for actual time and materials cost shifts the risk of inflation to the customer. Customers may not accept this approach because it doesn’t place limits on costs.
• Price adjustment mechanism – Language that permits an increase in price under specific circumstances, such as – if the cost of concrete exceeds X then the price of the contract may be increased by Y.
• Collar – A price adjustment mechanism that works for both price increases and decreases. This can be a good alternative for commodity materials which can be subject to large swings in price.

Take Control of Inflation’s Impact on Your Working Capital with Factoring

Inflation increases the amount of working capital needed to fund a project and also negatively impacts your cash flow if left unchecked. Invoice factoring through funding sources such as Capstone is an excellent cash flow management strategy for construction contractors looking to combat inflation’s negative effects.  Business owners obtain the additional working capital needed to finance projects as well as the cash flow for operations. Factoring can be provided for a single invoice/ payment application, or as a program for all of your accounts receivable.  Credit approval is based on the financial strength of your customer, not the creditworthiness of your business.   

Keep in mind that in an inflationary environment, the value of your accounts receivable lessens the longer they remain outstanding.  Instead of waiting 60+ days for customers to pay, business owners can convert their outstanding invoices to immediate cash.  Having access to those funds provides you with staying power until cash flow catches up with expenses. 

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How Capstone Can Help

Capstone Capital Group, LLC is a leading commercial finance company that is focused on providing businesses with sufficient access to working capital. Capstone has the experience and resources to provide customized invoice factoring and PO financing programs that fit your needs in an inflationary environment. 

Please join us in congratulating Jessica Governara, National Marketing Director of Capstone, for being featured as one of The Secured Lender Magazine’s “Women in Secured Finance.”

Continuing the celebration of Women’s History Month, we are very proud to highlight Jessica’s contributions to our firm and the commercial finance industry.

https://www.sfnet.com/home/industry-data-publications/the-secured-lender/magazine/tsl-digital-issue

The first International Women’s Day was held over 100 years ago in March of 1911.  Since then it has transformed into a month-long celebration of the contributions and accomplishments of women around the world.   To commemorate Women’s History Month, Capstone is pleased to highlight an amazing woman’s contributions and innovative leadership success.

This year, we recognize and honor the woman behind one of the most accomplished companies in our portfolio: 

Susan Chavez, Vice President, Business Development & Operations for Recommerce Group, Inc.  

Susan Chavez is Vice President of Business Development & Operations at Recommerce Group, Inc. She has an extensive resume with over 20 years of experience in financial services and operations management. Based in North Carolina, Susan is responsible for business development, project & client management, forecasting/reporting, recruitment, and strategic planning.

Prior to joining Recommerce Group, Inc. in 2016, she held several executive-level roles in manufacturing and the banking sectors.

Outside of work, Susan has positively impacted many people in her community by teaching at-risk youth, mentoring incarcerated women, organizing various fundraisers, coaching baseball & soccer, and being involved with elementary school PTA. She is a mother and an avid Red Sox baseball fan striving to visit every major league baseball stadium in the U.S.

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We interviewed Susan to honor her career accomplishments and celebrate Women’s History Month. She is an accomplished businesswoman and has had a major impact on the growth of Recommerce Group, Inc.

You have worked with a variety of companies over the years. As you have progressed in your career you must have had a number of bosses. Some may have been just managers while others were leaders. In your view what makes you a good leader?

The characteristics of a good leader that I focus on emulating include: versatility, adaptability, and understanding the importance of every role in an organization from the janitorial staff to the CEO.  Taking a stand with a fact-based approach. Having the ability to make decisions while collaborating. Always learning. Dressing for the job you want (not the one you have). Waking up every day and proving why you deserve the role you are currently in with moral and ethical work.  Always giving the “Good, Bad and Ugly” to each client, internal & external, to build trust and open communication.  But most importantly, always mentoring the next you – your successor.

What advice would you offer to women just starting out in business that have a desire to work their way up the corporate ladder into a leadership position?

Learn the industry through leveraging professional associations, such as RLA (Reverse Logistics Association) and various tradeshows (RLA, Consumer Returns, International Housewares, etc.).

Learn your company through taking the time to understand each role, interdependency, clients’ perspective (how do they view you), barriers to success, and what is the “Good, Bad and Ugly” view from associates’ perspective within your Company. 

Build your path by evaluating what roles, skillsets, etc. you need in order to get to the leadership position you strive for (including dressing the part).

As a successful woman have you run into barriers, and if you have please describe them and the tools you used to overcome them?

Barriers are a constant in business, but typically they are just tension/conflict points between various groups within an organization.  For example, Business Development vs. Operations; we both want growth, it’s just a matter of how quickly it can happen.

Most successful people have a mentor or other influential person in their life that they model their behavior on. Is there a particular woman who either mentored you or you modeled your behavior on?

I believe every woman is influential in their own way depending on the topic at hand.  As I look back through my life, an individual I have admired and desire to live like is Princess Diana. Not for the fame or lifestyle, but these simple tenets:

• Be kind to all. 
• Serve a purpose beyond work and your home.
• Always have a servant’s heart and be willing to take a stand.

Some women have to make stark choices to succeed in their business careers.  Can you provide any secrets to our readers on how you have successfully balanced your work and family responsibilities?

As a working Mother, candidly it is a constant struggle. However, I have set boundaries and priorities. Some weeks I am good at keeping them, and other times I fail. I never want to miss a school activity, sporting event, extracurricular activity, field trip, etc. My priorities and what drives me have changed drastically over the last eight years.  

How has Invoice Factoring with Capstone impacted Recommerce’s business growth?

The ability for a startup company, like our situation, to see immediate access to cash flow is what drew us to invoice factoring.  Factoring is more important with larger clients that typically have longer terms. It enhances cash flow stabilization and utilization.  Capstone has provided the ability to increase client mix through funding to support expansion and improved cash flows with larger Fortune 100 companies that expect longer terms. 

The partnership/relationship we have built with Capstone from essentially Day 1 of onboarding some of the Fortune 100 clients we service today has been phenomenal. Recommerce is accountable for ensuring no dilution and presenting credit-worthy clients to be factored. Capstone assisted with not only factoring. They also provided purchase order financing support during expansion phases of our business.

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About Recommerce Group, Inc.

Recommerce Group, Inc. is an industry leader in returned product management, return center services, remanufacturing, reprocessing, repairing, and recycling of consumer products. For over two decades the management team at Recommerce has been servicing some of the world’s leading consumer product manufacturers.

At Capstone, making sure all businesses have sufficient access to business financing options is at the core of our business strategy.  That’s why in 2012, Capstone created its Diverse Funding Program which is designed to give MWDBEs the financing tools they need for growth and to be successful.  Capstone began their program before “Diversity” was a buzzword thrown around by politicians and certain interest groups.  We have been a leader in the space because it made good business.  

Through this program, Capstone provides minority, women, and disadvantaged business entities, or in short “MWDBEs,” with access to financial and professional development support.  Those businesses participating in Capstone’s program avail themselves of many non-funding benefits including:  

• Local and personalized services all over the United States
• One-on-one business consulting and mentoring
• Customized training, leadership, and executive development  
• Procurement guidance
• Relationship building between MWDBE clients and larger corporations as well as access to governmental and municipal markets 
• Non-legal contract review
• Access to bonding
• Bid support letters
• Budgeting and forecasting development and support 
• Referral services for accounting, estimating, legal, engineering, payroll, and other professional services 

These additional benefits also make sure our clients are able to take advantage of the programs that have been set up for them by Fortune 1000 companies as well as state, city, and federal agencies.  Capstone has served as a primary or secondary financing source for a variety of MWDBEs.  In the last 10 years, we have seen much success with this program and have provided funding in excess of $100MM+ to qualified MWDBEs. 

Client Spotlight

Capstone is proud of the contributions it has made assisting MWDBEs with custom-tailored diverse funding programs, mentoring, and coaching over the last decade.   The below case study highlights the success and level of community improvement achieved by one of our MWDBE clients participating in the program. 

Fostering a Chance in the World through Invoice Factoring

In 2016, Capstone began working with a Pennsylvania-based non-profit advocacy organization dedicated to improving the futures of children in foster care.  Their mission was to provide a safe and caring home for all at-risk children in foster care in the Philadelphia, PA region. The organization also provided food, clothing, and therapeutic services to households of up to six children.

This client, a minority woman-owned business, came to Capstone because they were having a very difficult time accessing working capital as a non-profit organization.  Without sufficient cash flow, the client would struggle to manage cash due to irregular payment schedules.  In an effort to sustain operations, have the ability to expand, and open additional homes so they could get more children adopted, the organization sought out Capstone’s assistance for their funding program.  Invoice factoring would be the fastest way to generate immediate cash flow.  

Capstone’s solution was to provide a factoring facility to inject the necessary working capital required while providing the flexibility needed for a non-profit organization.  The client was able to factor invoices as they needed to.  Capstone also helped the client by increasing their advance rate to give them as much funding as possible and worked with them through contract extension periods.   The client contracted with state agencies and oftentimes there were a few weeks when the agencies delayed payments while they reconciled accounts at the end of their fiscal year.  The factoring solution helped keep the client stabilized during this period.  

After a few years of using Capstone’s factoring facility, the client was able to open additional homes and increase the number of children they are able to foster.  As a result, the client has been able to invoice more as they fostered and tutored additional children, thereby creating more cash flow for them to continue expanding.  They also went on to be awarded a seven-figure public agency project with the City of Philadelphia, which has been renewed for 2022 and is expected to be renewed in future years.   

Since working together, additional homes for boys and girls have been opened and there are plans to add more homes.  The client has maintained an invoice factoring relationship while utilizing other non-funding benefits of the Diverse Funding Program and has chosen Capstone as the preferred funding source.  Capstone’s factoring facility was integral to the organization maintaining operations throughout the COVID-19 pandemic while many others in the industry were stretched thin.  Many state agencies across the nation delayed payments as they struggled to manage the effects of the pandemic.  However, with factoring, the main portion of the payment is provided up-front, so any delays in payments aren’t as harmful. 

About Capstone

Capstone offers flexible factoring options for businesses in many industries. In particular, we understand the unique challenges faced by MWDBEs and we have been able to structure a funding platform specifically to support the working capital needs of these types of businesses. Capstone has experienced professionals on staff to custom tailor financing solutions for MWDBEs, and provide consultation and assistance to help them attain their goals and enrich their communities.  Whether it is a single invoice or full-contract factoring, Capstone can supplement these facilities with its Diverse Funding Program.  If you are part of one of these groups, we encourage you to contact Capstone to discuss your specific financial needs and learn more about our program.