In a business, being profitable is not enough. You also need to have a positive cash flow, i.e., have more money coming in than going out. This is because a negative cash flow will render you incapable of paying your expenses.
However, since revenues are generally generated either at a fixed interval or in the form of receivables, more often than not, you will be faced with situations where you would find yourself with a lack of resources to pay for your expenses or the purchase of working capital. This is where borrowing comes in.
Debt financing allows you to get your hands on cash right now at the expense of an interest. When you borrow against future sales, you are expected to repay the borrowed cash along with an added interest with the help of the revenue you will generate in the future. There are various advantages and disadvantages of borrowing against future sales.
Debt financing can allow you to reap the following benefits.
Correcting the Imbalance
Borrowing against future sales allow you to pay off your expenses and make the necessary investment in the present rather than waiting for the realization of sales. Since sale revenue may take a long time to be realized owing to the fact that most companies tend to conduct the business of credit and receivables, debt financing ensures that the investment needed is not delayed because of a lack of funds.
Continued Control of the Company
Some might argue that equity financing is much better than borrowing against future sales. After all, you don’t always need to pay dividends. However, while equity financing decreases the monetary burden on the firm, it does lead to dilution of control. Debt financing, on the other hand, does not decrease your ownership in the company, and neither does it give the lender the power to have a say in the running of the business.
Borrowing against future sales is not without its set of disadvantages, which may include the following:
Consequences of Not Repaying Loans
Borrowing against future sales means that you are putting a lot at stake over something which has either not yet happened or not been realized yet. For instance, if you project that your earnings in the future will be high enough to absorb the cost of borrowing if you undergo a certain investment, you are inclined to borrow. However, what happens when your prediction doesn’t come true?
Similarly, let’s say you plan on paying back the loan when your customers pay their receivables. At the last moment, though, some of your customers are unable to pay the amount. How will you then pay your lenders?
In both these cases, you can’t just put off paying your lenders since the terms are fixed and an inability to repay can lead to grave consequences which may include seizing your assets.
Lack of Growth
By allocating your future earnings as a way to pay off your debtor, you are curtailing the prospects of business growth. This is because a major way a business can grow is through reinvestment of future earnings.
However, if you plan to pay your debts from these earnings, you won’t have any resources to reinvest. Instead, you might be required to borrow more for such investment, thereby sucking you in a vicious cycle.
Borrowing Against Future Sales Conclusion
All in all, borrowing against future sales may or may not be the ideal solution to your funding problems. It all boils down to the amount you are borrowing and whether it constitutes all of your future cash flows.
Make sure you are equipped to pay off your debts when a customer defaults. Don’t stifle your growth. If you can avoid the shortcomings of such borrowings, there is nothing stopping you from doing it.