Purchase Order Finance What is Purchase Order Finance? Purchase Order Finance (POF) is a transaction-specific form of working capital/trade financing. It is a loan or advance, secured by a purchase order or contract, to pay for inputs, raw materials, packaging, goods for resale, etc., needed to produce and ship a product or deliver a service. It is not a traditional term loan or line of credit for the general operations of a business. When done properly, POF can be profitable and safe for the lender, enable companies to grow rapidly, and increase sales, exports, profits, and employment. Companies only pay interest for the exact number of days they need the advance, not a single day more. POF is an incredibly flexible instrument and can be tailored and adapted to the country, lender, value chain, types of orders/contracts, the borrower and the borrower’s customer(s). How does Purchase Order Finance work? A typical Purchase Order Finance transaction works this way: 1. A company obtains a verified purchase order or contract from a customer. 2. The company estimates the direct costs (e.g., raw materials, packaging, goods for resale, labor, shipping, insurance, etc.) required to produce and deliver the product or service. 3. The company approaches a lender about financing using the contract as collateral. 4. The lender reviews the order, the cost breakdown and the company’s operating record. 5. The lender evaluates the creditworthiness of the customer that issued the purchase order and assesses whether the company can deliver according to the terms of the order/contract. 6. If the loan is approved, the lender advances a percentage of the total order value to enable the company to produce and ship the order (or deliver the service) and issue the invoice to the customer. 7. The invoice (accounts receivable) is assigned to the lender, so that payment on the invoice is made directly to the lender. 8. When the customer pays the invoice, the lender is repaid the principal, interest and any fees and remits the balance to the company. 9. This cycle can be repeated over and over with new purchase orders to dramatically increase the sales of the company. Copyright © Crimson Capital Corp. 2011 COMPETE PROGRAM 123 Gardenia Road, Gigiri, Nairobi, Kenya Phone: +254-20-421-2000, Email: info@competeafrica.org, Website: www.competeafrica.org Case Studies in Purchase Order Finance POF has been used in the United States with great success and in recent years has been introduced in emerging markets such as Armenia, Azerbaijan, Bolivia, Kosovo, Macedonia, Moldova, and South Africa, both through banks and specialized non-banking financial institutions. Coffee Sector Financing in Bolivia In 2008, a rural coffee producer association representing 260 members received an order from a Dutch company for 19.6 metric tons of organic Arabica. The association and the Dutch buyer agreed to a price of US$ 55,664 ($2.84/kg); however, because the association lacked the financial resources to fill the order, they were unable to commit to the contract. With technical assistance and training from the USAID-funded Rural Competitiveness Activity FIE FFP, a private Bolivian microfinance institution, provided a US$ 30,000, 90-day (period to produce and ship the order and for the customer to pay) working capital advance to the association through a POF loan. These resources were used to process the coffee and cover other preshipment expenses, allowing the association to take advantage of this opportunity. The association assigned the invoice to FIE FFP along with an invoice from a previous export and a portion of its savings deposited at FIE FFP. No other fees or traditional collateral – such as real estate or mortgages – were needed to finance this operation. The export was a huge success for the association and its members and the loan was repaid on time when the Dutch company paid the invoice. According to the cooperative’s manager, “Purchase order financing allows us to use our own product to collateralize exports and fill more demands. This is a real innovation, a financial facility that ultimately benefits all our members.” Based on the success of this initial transaction, FIE FFP rolled out POF throughout Bolivia, expanded the product to other sectors such as palm heart, cocoa, pineapple and banana, and financed 242 transactions worth over $2 million. Pharmaceutical Value Chain Financing in Armenia In 2010, a privately held pharmaceutical manufacturer in Armenia needed working capital to fill export orders to Western Europe and the Former Soviet Union. However, the company rented its facilities and therefore had no real estate collateral, only some equipment and raw materials. This was not enough to secure the additional bank financing needed to fill these orders. Without financing the company would not only lose these orders but also the customers. The USAID-funded FS Share project helped INECOBANK develop and introduce a POF product, and the bank approached the company promoting POF to finance its export orders. For an order from a Kazakh customer, INECOBANK provided an advance to the company of US$ 10,000 for five months (transaction cycle to payment of invoice). A second POF loan in the amount of US$ 17,000 for six months, used to procure inputs, was secured based on an order from another Kazakh importer. According to the company’s financial director, POF provided critical financing when it was needed most – pre-shipment upon receipt of the order, which enabled the company to procure raw materials, packaging, etc., and prepare and ship the order. Before POF, the company had to frequently turn down business because its line of credit was fully utilized and it couldn’t otherwise obtain more financing. In 2010, the company increased its sales by 30%. Launching Purchase Order Finance in East Africa USAID COMPETE, through a competitive tender, will select at least two banks in East Africa to participate in its program to develop and launch Purchase Order Finance for increasing regional and international trade. POF is particularly well suited for the development of the cotton, textiles and apparel industry in Africa, where access to working capital financing with tenors that match the specific requirements of the orders is severely needed. For more information on Purchase Order Financing or the East Africa launch please contact: Ramiro Ortega Landa: ramiro.ortega@crimsoncapital.org or Chris Donohue: cdonohue@competeafrica.org COMPETE PROGRAM 123 Gardenia Road, Gigiri, Nairobi, Kenya Phone: +254-20-421-2000, Email: info@competeafrica.org, Website: www.competeafrica.org