Perhaps the most common challenge faced by businesses of all types and sizes across different industries is managing cash flow. Companies might experience times when internal funds are insufficient to sustain the cash cycle. During such times, they require external cash assistance to temporarily bridge the gaps and stabilise business operations. In addition to internal issues, external factors can also create the need for cash flow support.
In these situations, many businesses initially consider taking out a traditional loan. While this option may suit some, it is not suitable for everyone. Certain businesses struggle with the lengthy application process, while others fail to meet the strict credit score requirements. This is where the sale of future receivables comes in. The process works just as the name suggests: businesses can access immediate working capital by selling a portion of their future receivables (typically, their upcoming card sales or total revenue).
What Does Selling Future Receivables Mean?
The sale of future receivables is an agreement between a financial provider and a business.
In this process, a third-party company purchases a portion of a business’s future receivables and provides immediate funds in return. It is different from traditional loans, which involve borrowing money and making repayments over time with interest. Instead, this approach allows the business to give a percentage of its upcoming sales to the provider until the agreed-upon amount is fully settled. In addition to repaying the total amount, the business also pays a fee for the service.
In simple terms, it’s like receiving the income from your future sales ahead of time, without dealing with monthly fixed loan payments or the lengthy process of loan applications.
Let’s now explore how this process works in more detail.
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Sale of future receivables: How does it work?
Here is a step-by-step breakdown of the process through which a business sells its future receivables to a third-party financial institution.
1. Agreement between the business and provider
The process begins when a business and a funding provider reach an agreement. The business decides to sell a portion of its future receivables, which usually come from its sales profit, card transactions, or customer invoices. In return, the funder provides an upfront lump sum of cash within a short time of 1-4 days.
2. Flexible repayment schedule
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. Costs 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.
Types of sale of future receivables
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 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 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.
Sale of future receivables: Pros and Cons summary
| Pros | Cons |
|---|---|
|
Funds delivered within 1-3 days. |
Higher cost than traditional loans. |
|
Quick access for urgent needs. |
APR ranges between 50% and 150%. |
|
Approval based on sales history. |
Early repayment offers no discount. |
|
Not dependent on credit score. |
Repayment amount fixed regardless of speed. |
|
Easier qualification for poor credit. |
|
|
Repayments tied to sales. |
|
|
Lower payments during slow months. |
|
Advantages 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 for a lengthy loan process.
2. Lenient credit requirements:
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 its payments will reduce during quieter months, giving it breathing room without defaulting.
Disadvantages of selling 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.
That is why choosing the right provider from the start is important. The terms and conditions vary widely between lenders, and the wrong choice could put unnecessary financial pressure on your business. To avoid such a situation, make sure to compare your options carefully to choose the most suitable provider.
Make your sales of future receivables efficient with ComparedBusiness UK
We at ComparedBusiness UK can help you secure multiple ways of selling your future receivables, like merchant cash advances from top vendors in the UK. Just submit your requirements in less than 2 minutes, and we will match you with reliable financial institutions in the UK. You can pick and choose the best option as per your business requirements.
FAQs
The sale of future receivables does not involve borrowing money with monthly repayments and interest. Instead, a business agrees to forward a percentage of its future sales until the agreed amount is fully repaid, along with a fee for the service.
Compared to traditional loans that can take weeks to process, businesses can usually receive funds within 1-4 days after reaching an agreement with the provider.
Receivables can come from different sources, such as card transactions, unpaid invoices, or overall monthly revenue. The exact type depends on the method chosen by the business, such as merchant cash advances, invoice factoring, or revenue-based financing.
The main benefits include quick access to cash, flexible repayments tied to sales performance, and more lenient credit requirements compared to traditional loans.
