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Purchase Order Financing: A Turnaround Tool for Companies Selling to Retailers

Any commercial finance executive today is sure to have a real-world example or anecdote about the many ways e-commerce has reshaped the retail sector and subsequently impacted his or her clients. Though generally healthy, the retail sector seems to be in a constant state of disruption, with shifting consumer behaviors dictating business strategy and ultimately determining which businesses will survive and which will not.

But according to the National Retail Federation, while store closings and openings are dominating the headlines, more brick-and-mortar stores actually opened in 2018 than in 2017. There are countless examples of how both new and established retailers have adapted to changing consumer demands and the expansion of the e-commerce marketplace.

None of this is news to lenders—and certainly not to the turnaround professionals who work every day to help rehabilitate many of the companies that have felt the burden of these challenging conditions. In the current environment, even the healthiest business will eventually reach a point when credit will inevitably tighten and liquidity will no longer be readily available. When that happens, what is a business to do?

For starters, there are a few key indicators that can signal when a company is headed straight into a turbulent and potentially untenable financial situation. Perhaps the company’s financial statements reflect looming instability, or it becomes clear that operating performance is steadily declining. Questions about management’s expertise and aptitude at navigating this uncharted territory often arise, so a seasoned turnaround consultant may be brought in to assess the situation. Unless the business is quickly rehabilitated and stabilized, it is at risk of deteriorating rapidly from there.

When things begin to unravel, the collateral coverage under the credit facility tightens, which almost always leads to insufficient funding at a most critical juncture. Trade terms with key international suppliers are put in jeopardy and, depending on the severity of the circumstances, are either significantly reduced or terminated altogether. Even with all of these obstacles looming under the surface, demand for the company’s product is still high and sales continue to flow in. That positive glimmer of hope is an important sign of turnaround potential.

In the current retail market, especially with the pressures and demands of e-commerce as an added layer, this scenario has become all too familiar. When a company is reaching its breaking point—whether due to rapid growth, seasonal demands, or even external factors like trade tariffs—its lenders are often faced with important decisions about selecting the mix of financing solutions that will offer the best support. More and more, various parties involved—whether lenders, turnaround consultants, attorneys, or accountants—have added purchase order financing to the arsenal of turnaround solutions.

Getting Back on Track

For some companies, existing lenders don’t act quickly enough to prevent a precarious situation from turning grim before the company has a chance to get back on track. When that happens, turnaround professionals are typically brought aboard to evaluate the business plan, prepare cash flow projections, recommend cuts to the operating budget, negotiate with key suppliers, and make other adjustments to assist the company.

While many lenders will hear the company out and may even be sympathetic to the narrative, even in the best of circumstances, most lenders would find it difficult to stand behind a company and approve an overadvance at this stage. Uncovering additional liquidity sources, whether through sales of slow-moving inventory, additional budget cuts, or even an uptick in shareholder support, is often not enough to get over the hump and correct a cash flow problem that’s spiraled out of control.

That’s precisely where and when purchase order financing can come into play. PO financing can be a comprehensive financing option that provides the kind of immediate relief a company needs when it feels stretched in a turbulent credit environment.

A short-term alternative inventory financing option, PO financing has long been used as a turnaround tool by wholesalers selling into brick-and-mortar retail. For a company selling a product into big box retailers, as an example, PO financing can help the business capture sales that would otherwise have to be passed on because of liquidity concerns or unfavorable trade terms with suppliers.

In today’s complex retail environment, companies need to simultaneously navigate the intersection of their e-commerce and brick-and-mortar platforms without sacrificing one over the other. Lenders are discovering that much of the inventory analysis that goes into financing a company selling into brick-and-mortar—individual SKU analysis, product sourcing, quality control, logistics, and delivery, to name a few—can also be used to fund and finance e-commerce businesses.


 
An intercreditor agreement allowed for a smooth transition from PO financing back to asset-based lending once the related accounts receivable were generated as a result of the purchase order financing.

 


For example, a popular consumer goods importer found itself with larger than expected sales programs from both existing and new retail customers, brick-and-mortar and e-commerce alike. Needing to fulfill the orders in time for the upcoming fall and holiday seasons, the company first reached out to its existing lender, the asset-based lending division of a regional bank, to help alleviate the cash flow strain it was experiencing. While the lender was supporting the company with a $15 million overall facility, which included an approved overadvance facility, the bank was unwilling to increase that overadvance to the level required.

To further complicate matters, overseas suppliers that had previously granted open terms to the company were no longer willing to extend those terms and required preshipment financing to produce the company’s products on time.

Given the extraordinarily large seasonal inventory build, the client’s existing lender encouraged the company to pursue PO financing to assist with its increasing financing needs. An intercreditor agreement allowed for a smooth transition from PO financing back to asset-based lending once the related accounts receivable were generated as a result of the purchase order financing. With a multimillion-dollar PO financing facility, the client was able to obtain goods from multiple overseas suppliers by issuing letters of credit. Freight, duty, and logistics costs were all financed, and the required inventory was funded at a 100% advance rate.

As a result, the overseas suppliers received the credit enhancement they required to ship the products, and the lender did not have to increase its overadvance. In fact, the lender was better positioned to have the overadvance repaid by the incremental cash flow generated through the PO financing. In addition, the facility allowed the client to leverage its higher margin brick-and-mortar sales orders to provide additional support for inventory on the company’s online orders.

In other scenarios involving importers like this, a PO funder would first need to evaluate the quality of the end customer purchase orders. Are they actual sales with specific deliverables or replenishment orders, or are they simply forecasts from a potential end customer and not confirmed sales? Validating the gross margin being produced by the sales backlog that’s still increasing is also vital. All of this upfront analysis is vitally important.

If the analysis checks out, the company would be financed to cover the inventory required to fill the sales backlog at an advance rate of up to 100% of the cost of the goods. Other costs, including freight, duties, and warehousing, could also be financed, and suppliers would be paid directly for products and materials.

The PO funder would institute a preshipment independent inspection as a quality control requirement to help mitigate potential dilution due to product quality issues that might arise. All of this would be done without any disruptions to the manufacturing process, and product delivery to the end customer would continue uninterrupted.

The importer is also able to create additional borrowing base availability for the factor or asset-based lender through the resulting increase in eligible accounts receivable. Once the PO funder is repaid, the factor or asset-based lender determines how much of the remaining balance can be used to reduce past overadvances or, in the best-case scenario, put working capital directly back into the borrower’s bank account.

Importers aren’t the only companies that can make use of PO financing. Light manufacturers, wholesalers, assemblers, distributors, exporters, and even government contractors that face cash flow challenges can also avail themselves of this financing option. For those in a turnaround situation, a company that requires incremental liquidity to rehabilitate trade terms with suppliers is a strong candidate.

Conclusion

A PO financing source should be creative, flexible, and tolerant, and have experience operating in challenging credit environments, both for trade cycle financing for finished goods transactions and production financing for work in progress funding. A demonstrated capability for structuring and negotiating complex agreements with other lenders, as well as any equity stakeholders, is also important. In addition, a PO funder should have its own reliable funding capability and not be dependent on raising supplemental capital from investors or relying on outside approval.

Taking the time to select the most suitable option to address a complicated liquidity challenge can result in a positive outcome for all parties involved. The existing factor or asset-based lender is no longer forced to provide additional overadvances, and the borrowing base creates more accounts receivable coverage, which, in turn, decreases inventory reliance. The company’s supplier is paid on time and the gross margins from sales generated by PO financing can address past-due payables or assist in rehabilitating trade terms. The company’s retail customers receive their finished products on time, which maintains confidence that the company can continue to fulfill orders on time in the future.

All of these elements play a role in creating a more effective turnaround strategy, one that doesn’t just create an additional layer of liquidity but also additional transactional working capital for a company straddling both brick-and-mortar and e-commerce business. Without the stress of cash flow looming over them, companies can avoid seeking out equity from outside investors and diluting ownership in their businesses, a major pain point for any entrepreneur or business owner.

Paul Schuldiner

Paul D. Schuldiner

Rosenthal Trade Capital

Paul D. Schuldiner is an executive vice president and division head at Rosenthal & Rosenthal and leads the Rosenthal Trade Capital division. With more than 20 years’ experience in the purchase order and trade finance business, Schuldiner started his career in the asset-based lending and factoring division of a New York City-based finance company and practiced as a CPA in public accounting. He is a member of the TMA New Jersey Chapter board.

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