The business environment has always been competitive. And maintaining a healthy cash flow has been critical for the survival and growth of any company. Whether it’s covering operational costs, managing payroll or investing in new opportunities, businesses often face periods when they need quick access to funds.
Traditional loans may not always be the best option due to the lengthy approval process and strict requirements. This is where the sale of future receivables comes into play. By selling a portion of their future income, businesses can secure immediate capital to meet short-term needs without taking on traditional debt.
What is the sale of future receivables?
The sale of future receivables is a financing method where a business sells a portion of its anticipated future income to a funding company in exchange for immediate cash. Instead of borrowing money and repaying it over time, the business agrees to forward a percentage of its future sales to the funder until the agreed-upon amount is fully paid back.
Think of it as a flexible, no-strings-attached financial boost without the formalities of traditional loans. It’s a solution that puts cash in your hands without the debt – perfect for businesses with fluctuating revenue cycles.
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How does the sale of future receivables work?
1. Agreement between the business and the funder
The process begins with a business and a funding company reaching an agreement. The business agrees to sell a portion of its future receivables, typically revenue generated from sales, credit card transactions, or customer invoices. In exchange, the funder provides an upfront lump sum of cash.
For example, if a business needs £50,000 in funding, they might agree to sell £65,000 of future receivables. The business gets the £50,000 immediately, and the funder will collect a percentage of daily or weekly sales until the £65,000 is fully repaid.
2. Flexible repayment based on sales
Repayment is structured to be flexible and linked to the business’s actual revenue. A fixed percentage, often ranging from 10% to 20% of daily or weekly sales, is automatically deducted and sent to the funder. This percentage is called the holdback rate.
The key advantage here is flexibility. If the business experiences slower sales during certain periods, the repayment amount decreases proportionally. On the flip side, if sales pick up, the business can pay off the advance faster.
3. Minimal credit requirements
There’s the benefit of the ease of qualification. Since repayment is tied to future sales, funders focus less on credit scores and more on the cash flow history of the business. Typically, the businesses that have been operating for at least 6 months with consistent sales or receivables, are good candidates for this financing option.
4. Cost and fees
The cost of selling future receivables is usually structured using a factor rate. This is a fixed multiplier applied to the advance amount. For example, if the factor rate is 1.3 and the business receives a £50,000 advance, the total amount to be repaid is £65,000 (50,000 x 1.3).
Additionally, some funders may charge administrative fees or processing fees, so it’s important for businesses to review all terms before signing the agreement.
5. End of agreement
Once the business fully repays the purchased receivables, the agreement is complete.
How is the sale of future receivables processed? - The types
The sale of future receivables comes in different forms, each designed to meet various needs.
1. Merchant cash advance (MCA)
The most well-known type of future receivables sale is the Merchant Cash Advance. With an MCA, a business sells a portion of its future credit card or debit card sales in exchange for an upfront cash advance. It’s simple: you get the cash today and the funder takes a percentage of your daily sales until the advance is fully paid back.
This option is particularly popular with industries that have steady credit card sales, like retail stores, salons and restaurants.
According to an article by Merchant Savvy, the approval rate for SMEs can be as high as 90% for MCA and only 62% for traditional business lending.
2. Invoice factoring
Got a stack of unpaid invoices just sitting there? Invoice factoring might be the answer you’re looking for. In this setup, a business sells its unpaid invoices (accounts receivable) to a factoring company for an upfront cash payment. The factor then collects the payments directly from the customers.
What’s the benefit? Cash flow. Instead of waiting 1-3 months for your clients to pay, you can get up to 90% of the invoice value right away. The factoring company takes a small fee and handles the collections, so you can focus on running your business instead of chasing down late payments.
3. Revenue-based financing
Unlike MCAs, which focus on credit card sales, revenue-based financing involves selling a portion of your overall monthly revenue. The repayment is based on a fixed percentage of your gross income, which gives it similar flexibility to an MCA, but it’s not limited to card sales.
This option works for businesses that generate income from multiple sources, not just credit card payments.
4. Royalty financing
Royalty financing is another form of future receivables sale where a business sells a percentage of its future revenue in exchange for upfront capital. However, the unique aspect here is that payments are often structured as royalties, based on specific revenue streams.
This method is common in industries like tech startups, where future revenue may come from product sales or intellectual property.
Which method of the sale of future receivables is good for your business? The type of future receivables sale you choose depends on your business model and cash flow needs.
- Are you swiping credit cards every day? An MCA could be your lifeline.
- Have unpaid invoices piling up? Consider invoice factoring.
- Need flexibility with various income streams? Revenue-based financing might be your go-to.
Pros of selling future receivables
1. Quick access to cash:
One of the biggest advantages of selling future receivables is the speed at which you can receive funds. When compared with traditional loans that can take weeks to approve and disburse, an MCA deal can deliver cash within 1-3 days.
Example: A small retail business needing to restock inventory before a holiday rush can sell a portion of its future credit card sales and have the funds within a day. This flexibility allows the business to take advantage of the increased demand without waiting on a lengthy loan process.
2. Lenient credit requirement:
Unlike bank loans that generally require a credit score of 650 or higher to get approved, selling future receivables is more focused on your sales history and revenue streams.
Example: A restaurant with a fluctuating revenue stream and a credit score of 620 may struggle to get a traditional loan. However, with steady daily credit card sales, it can qualify for an MCA.
3. Flexible repayment terms:
Since repayments are based on a percentage of your daily or weekly sales, the pressure to meet fixed loan payments every month is eliminated.
Example: A salon that experiences slower seasons in the winter can benefit from this model, as their payments will reduce during quieter months, giving them breathing room without defaulting.
Cons of the sale of future receivables
1. Higher overall cost:
While selling future receivables offers quick access to cash, the cost is typically higher than traditional loans. The factor rates in an MCA or fees in invoice factoring may result in APRs that can range anywhere from 50% to 150% or more. You can calculate them easily.
Example: A business receives a £50,000 MCA with a factor rate of 1.4. The total repayment would be £70,000, meaning they pay an additional £20,000 over time, which could be significantly higher than a traditional loan at 8-10% interest.
2. No benefit of early repayment
Unlike traditional loans, where paying off early reduces the interest you owe, there is no discount for repaying receivables early. Whether you pay it off quickly or over a longer period, the total amount to be repaid remains fixed.
Comparison of advantages & disadvantages of the sale of future receivables
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Make sales of future receivables efficient with ComparedBusiness UK
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