Case Study: Purchase Order Financing for a Consumer Goods Manufacturer in Distress

A once successful consumer goods manufacturer found itself in a difficult position. The company had a track record of exceptional performance, often exceeding its own aggressive projections. Undercapitalized since inception, the company grew at a rapid pace, financed in part by its own profitability, but dependent to a far greater extent on the support of its bank. The economy had been good, the company creative, and the outlook appeared bright as ever. The company therefore had no difficulty in obtaining additional assistance from its bank to finance the acquisition of a competitor, when the opportunity arose. The acquisition funding was in part collateralized by the assets of the acquired company, but in the main, rationalized by the expected cash flow of the combined companies. It was a very aggressive loan.

A successful merger of the two companies was dependent upon rapid plant consolidations, and debt reduction, achieved through liquidation of excess equipment, and real estate. The plan was much better than its implementation, which fell woefully short of expectation. Machinery did not arrive on schedule and could not be installed when it did get there. Upon arrival, it was found that one of the new acquisition’s factories had neither sufficient power, nor the necessary concrete flooring to accommodate the more modern equipment intended for installation. As a consequence, the company was unable to produce, and found itself in a severe back order situation. Sales were deferred and profitability was lost. The company’s prospects for a reversal of fortune were not good.

To make matters worse, margins were also in a state of decline. In the years prior to the acquisition, the distribution sector of the industry had been consolidating. As a result, the company had fewer customers, and those that remained were large as well as demanding. The new mega customers insisted upon aggressive sales incentive programs as a condition of doing business, and successfully resisted the company’s attempt to increase prices.

The combination of declining margins, production problems, and the company’s inability to ship diminished the bank’s confidence with management. As a consequence, the bank suggested the services of a certified turnaround professional to its customer. Company management recognized that its relationship with the bank needed mending, and welcomed the opportunity to restore it while working with the turnaround group.

With the assistance of the turnaround people, every phase of the company’s operation, its market, as well as the industry was scrutinized and a plan to revitalize was created. It was immediately apparent that the company had three major challenges. The first was to find a way to improve margins, the second was to obtain product to satisfy purchase orders and the third was to maintain, not only its present bank support, but also to find a source of additional funding to accomplish the first two goals.

The plan to restore profitability was to convert the company’s focus from manufacturing to outsourcing. This would enable it to improve gross profit margin, divest itself of its manufacturing facilities, and use the proceeds to reduce debt. In fact, an off shore manufacturer was found with the production capabilities to duplicate the necessary product lines.

To make the transition, the company needed to quickly obtain financing for the purchase of inventory offshore to satisfy the backlog of orders. Delays would mean further losses. Material and labor costs were increasing, as customer demands for sales incentive programs intensified, and price increases were resisted.

Since the bank’s aggressive program could no longer be justified, additional financial assistance was sought through the services of a transaction finance company, specializing in purchase order financing. In order to accommodate the company’s sense of urgency, a program was in place within two weeks, which enabled the company to obtain 100 percent of the cost of the necessary inventory. The cooperative approach taken by the bank and transaction finance company was sufficient to provide the needed funding. Specifically, the bank continued to provide accounts receivable financing at its existing rates of advance, while new inventory was acquired through the services of the purchase order financer. As the new inventory was shipped, the bank’s advances against accounts receivable repaid the purchase order financer, and provided additional working capital.

Essentially, the two lenders working together, each relying upon their respective expertise, enabled the company to maximize its borrowing capacity to obtain the necessary financing, restore the company to its previous profitability and achieve a successful turnaround.

Purchase order financing is a creative source of funding that is a valuable supplement to traditional lending. It is, however, not restricted to turnaround situations, and should be considered in any situation that requires more financing than a conventional source will make available. Unlike a primary lender, purchase order financers are transaction oriented, seeking to bridge the gap between short-term needs, and long-term financial solutions. Purchase order financing can also serve a temporary need, as a viable alternative to additional equity or mezzanine debt, such as when the dilution factor may be too great, or the market conditions unfavorable. When this occurs, the benefits of purchase order financing should be aggressively explored.

While purchase order financing is transaction oriented, the typical relationship with a transaction finance company is not a one-time event. In fact, once an association is formed, it is quite common that transaction finance will be utilized to structure continuing programs to facilitate subsequent opportunities very quickly, so additional inventory funding is available when needed.

Purchase order financing is ideally suited to operate wherever more financing is needed than can be provided by traditional lenders. It is most effective in those situations where product is outsourced either domestically or off shore. This is especially so in today’s global economy, which finds an increasing number of domestic manufacturers looking to outsource product overseas and requiring the issuance of letters of credit, as well as the expertise of dealing with international commerce, that is offered by transaction finance. The availability of this capability explains why more and more lenders consider purchase order finance as a valuable supplement to meeting the needs of their customers. It also provides a bank with the means to expand its own services without additional cost or risk, by utilizing the funding, services and expertise of transaction finance.

As globalization continues and foreign manufacturers expand their position to meet the outsourcing needs of their U.S. customers, purchase order financing is becoming a more popular source of supplementary financing.

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