Library & Learning Commons

Purchase Order Finance in the South African Context
Purchase Order Financing (POF) is a transaction-specific form of working capital financing. It is an
advance against purchase orders or contracts used to pay for raw materials, packaging, inputs, goods for
resale, etc., needed to produce and ship a product or deliver a service and complete specific customer
orders. It is not a general loan or line of credit for operation of the business. It is a highly targeted form of
trade financing, specifically designed to allow the company to fill a particular customer order. It is
adaptable, profitable and can be undertaken with minimum risk. However, most banks and other financial
institutions in South African do not typically provide it. Nevertheless , when done properly, POF products
can have an excellent return to the lenders, can make the difference between success and failure for many
companies, and can promote exports and
employment.
There is a confirmed market for POF products
for SMEs throughout South Africa. Learn
more about this essential working capital
product here and the work that FSP is
undertaking with partner intermediaries.
“I have the opportunity to place new product lines
and equipment in all of our franchisees’ stores, which
will increase both our and their sales, but I need
more working capital to fill my franchisees’ orders.
Purchase Order Finance is exactly what I need and it
will really accelerate the growth of my business.” A
woman-managed SME franchisor in South Africa.
With POF, a company obtains a verified
purchase order or contract from a customer and estimates the direct costs (e.g., raw materials, packaging,
goods for resale, labor, shipping, and insurance) required to produce and to deliver the product or service.
The lender reviews the order, the cost breakdown and the company’s operating record. The lender bases
the credit decision on whether the purchase order is from a creditworthy customer or is backed by a letter
of credit, guarantee or insurance, and on whether the company can produce and deliver the product or
service according to the terms of the order/contract. If the loan is approved, the lender advances a
percentage of the of total order value to enable the company to produce and ship the order (or deliver the
service) and issue the invoice. When the customer pays the invoice, the lender is repaid the advance plus
interest and remits the balance to the company.
Why is FSP promoting access to working capital and POF in South Africa?
The lending products that are currently on the market in South Africa for SMEs are limited – generally
term loans and lines of credit. With few exceptions, most South African financial institutions do not offer
transaction-based working capital lending to their customers and those that do, do so on a (currently)
limited basis. To mitigate this SME finance gap, South African Financial Institutions (FIs) could make
utilization of the tried and tested Purchase Order Finance (POF) product, several are currently
undertaking the pilot of such activities collaboratively with FSP
POF has been used in the United States with great success, helping small and medium sized enterprises
grow dramatically. In recent years, it has been successfully introduced in emerging markets by FSP
consortium member Crimson Capital, in Armenia, Azerbaijan, Bolivia, Kosovo, Macedonia, and
Moldova, both through banks and stand-alone specialized Non-Bank Financial Institutions (NBFIs).
Experience has shown the high demand for this product and, across borders, has been delivered with a
less than 2% default rate.
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What are the benefits to the lenders and the borrowers?
POF provides a number of advantages for SME borrowers. First, POF provides working capital early,
during the production process, allowing enterprises to fill larger and more frequent orders, to build their
customer base, to create employment, and to increase sales and exports. Second, as the purchase order
itself is the main form of collateral, POF does not usually require real estate collateral. And finally, the
tenor of the POF loan can be matched to the SME borrower’s order cycle, meaning that the SME pays
interest only the exact number of days for which it needs the money.
Lenders also benefit from utilizing POF. POF lending can implemented profitably, can help lenders
expand into the SME space and into new sectors/value chains, and can generate extensive cross-sales of
other lender products and services. With the development of a SME POF client base, experience has
shown that word of mouth “marketing” is the catalyst to exponential growth in the lenders SME market
segments stemming from client’s suppliers and buyers.
How does POF fit into the lending system in South Africa? What gaps does it fill?
It should be recognized that although lack of access to finance is cited as one of the biggest obstacles for
SMEs, the problem is not the result of a banking liquidity shortage or insurmountable regulatory
restrictions. On the contrary, there is huge excess liquidity in the financial sector in South Africa. The
problem lies in how to effectively mobilize this excess liquidity to the SMEs in a manner that will
catalyze the growth of the SMEs, and at the same time not increase the risk or reduce the profitability of
the banks. Unlocking this liquidity will require helping banks and non-bank financial institutions to
introduce SME-friendly financial instruments and learn how to better assess and lend to SMEs, and
helping SMEs be more ready and able to apply for and take on credit.
Clearly, there is a need for additional working capital finance instruments that SMEs can qualify for and
that help the SMEs grow, become more profitable, and increase employment. These instruments have
lower collateral requirements, often omitting real estate, and have tenors that match the product/service
cycle of the SME, so that the loans are transaction based, self-liquidating, and only bear interest for the
exact number of days the SME needs the money.
Working with financial institutions to address this working capital finance gap will have a significant
multiplier effect on SME growth, sales, exports and job creation in South Africa thus directly benefiting
traditionally disadvantaged populations and underserved market segments.
In addressing the SME financing challenges, USAID’s FSP has launched the Southern Africa Financial
Instruments Pilot Program or “FIPP” to ramp up working capital lending to SMEs. FIPP selected
financial institution partners through a transparent tender process and is now providing hands-on technical
assistance to help them launch Purchase Order Finance (POF), a type of transaction-based, pre-shipment,
working capital finance that is highly effective for stimulating rapid growth in SMEs sales, exports and
employment. POF is also sometimes referred to as vendor finance and pre-shipment finance. By the end
of the FIPP initiative (December 2011), the two selected partner financial institutions will have fully
integrated POF lending into their portfolios and extended POF loans to clients joining another bank who
developed this product with earlier FSP technical support.
This article was written by Michael Gold, the Managing Director of Crimson Capital
Corp. and Chairman of Crimson Finance Funds.
Crimson’s technical assistance and training to indigenous financial institutions and its own
lending funds have generated over $200 million in finance to farmers and SMEs, over $300
million in new sales and exports, and created thousands of new, permanent jobs. Globally,
Crimson has generated over $7 billion in debt and equity finance, foreign direct investment,
PPPs, and export transactions.
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