PO Financing, Factoring, and Merchant Cash Advances

Running a business often requires more cash than you have on hand. Whether it’s covering payroll, buying inventory, or waiting for customers to pay their invoices, the need for working capital never goes away. Traditional bank loans are one option, but they aren’t always available, especially for smaller businesses or those with less-than-perfect credit. Enter alternative financing.

Three of the most common alternative financing options are factoring, purchase order financing, and merchant cash advances. Each provides quick access to cash but works differently and comes with its own legal considerations and risks.

Factoring

Under a factoring arrangement, a company sells its accounts receivable, i.e., unpaid invoices, to a factor (a financing company) at a discount. The factor then collects the money directly from the customers when the invoices come due.

As Harvey Gross of HSG Services  explains, “Factoring is not a loan; it’s an advance against your receivables. The risk shifts to the factor, depending on how the deal is structured.”

Factoring gives businesses immediate liquidity without waiting for invoice payment. It’s especially useful in industries like trucking, manufacturing, or staffing, where payroll and supplier costs hit before clients pay.

There are two types of factoring:

• Recourse Factoring: If the customer doesn’t pay the invoice, the business that sold it must buy it back or replace it with another.
• Non-recourse Factoring: The factor assumes the risk of nonpayment, but only if the reason is credit-related, such as customer bankruptcy.

Factoring can also shift administrative burdens. Factors often handle collections, monitor customer payment behavior, and assume some credit risk management responsibilities. This allows businesses to focus on operations rather than chasing receivables. On the downside, customers may be notified of the factoring arrangement, which can affect client relationships if not managed carefully.

From a legal standpoint, factoring agreements should clearly spell out what happens in the event of disputes or late payments. Some agreements allow factors to ‘charge back’ invoices, essentially reversing the transaction. Business owners should also be aware that recourse factoring may leave them responsible for invoices that go bad.

Purchase Order Financing

Sometimes the challenge isn’t collecting payment, it’s fulfilling the order in the first place.

Under a purchase order (PO) financing arrangement, the financing company pays the business’s supplier directly for the goods. Once the business delivers the finished product and invoices the customer for payment, the arrangement is typically converted into a factoring deal to pay off the PO financing. The cycle ends when the customer pays, the factor gets reimbursed, and the business pockets the remainder.

PO financing is especially common among importers, distributors, and wholesalers that operate on thin margins but handle large volume orders. Without PO financing, many growing companies would be forced to turn down lucrative contracts.

As Jennifer Draffkorn of Rosenthal & Rosenthal, Inc. notes, “PO financing is about giving companies the ability to say yes to opportunities they otherwise couldn’t afford.”

However, PO financing can be expensive. Rates are higher than bank loans, and fees accumulate as the financing rolls into factoring. Businesses considering PO financing must weigh the costs carefully. PO financing fees are layered on top of factoring fees, creating a ‘double dip’ effect. The economics work best when profit margins are comfortably above financing costs. Legal diligence includes confirming supplier reliability and customer creditworthiness. Disputes about shipment delays or defective products can leave the business on the hook even after funds are advanced.

Merchant Cash Advances

Merchant cash advances (MCAs) became popular in the early 2000s, starting with companies that had high credit card sales. Today, they’ve expanded to almost every type of small business.

Under an MCA arrangement, the financing provider advances a business cash in exchange for a percentage of its future receivables. Payments are usually collected daily or weekly through ACH debits from the business’s  bank account. Unlike loans, MCAs are technically structured as sales of receivables, which is why they often aren’t subject to state usury laws.

MCAs appeal because approval is fast, sometimes within 24 to 48 hours, and providers often require minimal paperwork. Credit history is less important than cash flow, which makes them accessible to businesses shut out of bank lending. However, the speed and flexibility come at a cost.

The effective annual percentage rate (APR) can be enormous, sometimes exceeding 100%. They can trap businesses in a cycle of debt, especially if the business doesn’t grow fast enough to cover the daily repayments.

As Michael Weis of Weis Burney LLC  warns, “MCAs are marketed as quick and easy cash, but they come at a steep price if you don’t understand the repayment terms.”

Critics argue that MCA providers sometimes exploit desperate businesses. High APRs and daily ACH withdrawals can strain cash flow to the breaking point. A company might find itself in a cycle of taking one MCA to pay off another, creating a debt spiral. Legal disputes often arise over whether these transactions are true sales of receivables or disguised loans subject to state usury laws.

Comparing the Options

As Jacqueline Brooks of Duane Morris LLP  notes, “These tools aren’t one-size-fits-all. The right choice depends on your business model, your margins, and your risk tolerance.”

• Factoring is best for businesses that need steady working capital and have reliable customers who pay, albeit slowly.
• PO Financing is ideal in situations where a business lands a big order, but doesn’t have upfront capital to fulfill it.
• MCAs are a last-resort option when a business needs fast cash and can handle rapid repayment.

When comparing options, businesses should look beyond the straight cost. Control provisions, personal guarantees, and the effect on customer relationships all matter. While factoring may involve customers dealing directly with a factor, PO financing usually remains behind the scenes.

Conclusion

Alternative financing can provide critical breathing room for businesses that need cash quickly. Factoring, PO financing, and MCAs all serve different purposes, but none are free of risk. The smartest business owners use them with eyes wide open by understanding the legal terms, calculating the true costs, and aligning the financing with their long-term goals.

When considering any form of alternative financing, remember to:

• Do the math. Calculate the effective APR of any deal. An MCA that looks manageable week-to-week may cost more than triple a traditional loan.
• Understand the contracts. Read the fine print or, better yet, hire a legal professional to review it for you. Hidden fees, automatic renewals, or aggressive collection terms can ruin a deal.
• Don’t overextend. Using multiple layers of financing can create a web of obligations that becomes impossible to manage.
• Use these tools strategically. Factoring or PO financing can be a bridge to growth, but they shouldn’t replace building a healthier balance sheet or negotiating better terms with customers.