What is a Merchant Cash Advance?
A merchant cash advance (MCA) is a form of financing that allows a company to sell a portion of its future sales in exchange for an immediate payment. This financing provides your company with funds to pay operational expenses and to grow. There are a few ways to repay the advance, depending on your type of business. Initially, merchant cash advances were used solely to finance future credit card sales. Therefore, most clients were retailers and restaurants. The product has evolved to the point where cash advance companies can finance any future sales, regardless of how they are paid for.
Merchant Cash Advances vs. Traditional Bank Loans
A business can apply for and receive funds from a merchant cash advance company within a few days, versus a bank loan, which can take a few months. The application process for a merchant cash advance is significantly less burdensome than it is for a bank loan. A merchant cash advance company will look for sources that show a business’s cash flow, like recent bank statements, sales volume and credit card statements. A bank loan would rely more on credit history and hard collateral. The way in which a merchant cash advance gets paid back differs significantly from a traditional loan, which requires monthly payments. In a merchant cash advance, a predetermined percentage of the company’s daily sales is paid back to the merchant cash advance company on a daily basis until the purchased amount is fully repaid. The percentage that the merchant cash advance requires to be returned daily is called the "Holdback Percentage"
Determining The Funding Amount
The amount of funding is determined by a combination of your sales and the perceived risk of your account. Most cash advance companies advance anywhere from 80% to 150% of your average monthly revenues based on these parameters. The amount you must repay is determined by multiplying your financed amount by a “Return Factor.” The return factor can range from 1.09 to 1.50.
For example, a $100,000 transaction with a payback factor of 1.09 would require repayment of $109,000 over a period of time. Usually, the payback period ranges from 3 months to 15 months.
The actual funding part of the transaction is relatively simple. The funds are deposited to your account once the financing is approved.
How is the Factor Rate Calculated?
The interest a business pays on a merchant cash advance is calculated differently from a traditional loan. Interest rates tend to be higher because of the short-term nature of the advance and the added risk the merchant cash advance company is taking on with an advance. If a business is looking for an advance of $10,000, the merchant cash advance company may use a factor rate of 1.20x, and would require a final purchased amount of $12,000 to be repaid. The rate is always presented as a factor rate as opposed to a percentage – in this case the factor rate would be 1.20x.
Paying back the funds
Your company can repay the funds to the cash advance company in a number of ways. If you funded credit card sales, your company pays the finance company back through a percentage of its daily sales. This percentage, known as the “Retrieval Rate” can range from 8% to 13% of your daily sales. It’s paid back by implementing split processing with your credit card processor.
If you are not financing credit card sales, repayment happens by allowing the cash advance company to deduct funds from your bank account via the ACH system (direct withdrawal). Although most finance company debit your account every business day, some do so on a weekly basis.
Disadvantages/Advantages of Merchant Cash Advances
Merchant cash advances have some disadvantages. The main disadvantage of this solution is the cost of financing. As discussed in the previous section, this solution can be expensive. As a result, companies should use this product only after careful consideration – and only if they are able to grow the business and pay the lender back. If you have cash flow problems, an MCA may provide a short-term solution, but you will probably need to refinance the line a few times. Generally, cash flow problems are best solved using revolving financing, such as a line of credit.
However, this product has advantages as well. Most cash advances can be obtained quickly, in just days. Also, qualifying for a merchant cash advance is much easier than qualifying for a business loan. These advantages can make an MCA an attractive solution if your company has an urgent need for funding. Given the potential advantages and disadvantages of this solution, consider consulting with CASH@HAND, LLC for a honest evaluation.
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Note: We do not offer business cash advances. This article should not be considered financial advice and is provided for informational purposes only.