Why a Merchant Cash Advance Is a Popular Short-Term Business Loan Option

Business Expansion

Jacques Famy Jr
Review By Todd Millman

Merchant cash advances (MCAs) have become a popular alternative for small businesses seeking short-term funding. Unlike traditional bank loans, MCAs provide cash advances to businesses in exchange for a percentage of future credit and debit card sales. This financing option offers a fast and flexible way for small business owners to access working capital without putting up collateral or going through a lengthy approval process.

What Is a Merchant Cash Advance?

A merchant cash advance (MCA), a purchase of future sales agreement, advances money off future sales. The owner is responsible for paying back a fixed payback amount known as a specified amount, which is greater than the amount that was advanced to the company.

A “factor rate” is charged, which is the difference between the advance and payback amounts. Factor rates do not function like principal and interest rates. They are a flat fixed cost.  Merchant cash advances are connected to credit card sales instead of overall sales. MCAs take a set percentage of future daily credit card sales until the advance is paid back in full. The payment process provides more flexibility in repayment versus alternative loan solutions. Some merchant cash advances have early pay discounts; others do not, so check your agreements for terms. Cash advances are not considered a loan.

Often, business owners choose merchant cash advances because there are deficiencies in their qualifications for getting traditional financings like SBA loans, small business lines of credit, or short-term business loans. The most common obstacles for financing with traditional products include personal credit issues, time in business, financial statements like tax returns, profit, and loss, or bank statement health.

Merchant cash advances accept business owners with credit, which is unacceptable to traditional business financing. If you have bad credit, a traditional loan will not be an option. Additionally, no financial statements or assets are required to approve an MCA. Business bank account ledgers can be much thinner with lower average daily balances. Unlike traditional small business financing, which usually requires at least three years in business, MCA can begin to accept applicants with six months in business revenue.

Product Overview

Rates: Factor rates range from 1.09% up to 1.35% (not an interest rate)

Repayment Terms: Repayment period dependent on credit card revenue (estimated 6 to 18 months)

Fees: Origination fees 0% to 3%

Payments: Fixed percentage of future daily credit card revenue

Credit Profile: Poor to excellent credit accepted. (Credit scores from 500-850)

Time in Business: Minimum 6 months in business

Documentation: Application, 3 months business bank account and credit card statements Processing Time: Fast funding: Same Day to 48 hours

How a Merchant Cash Advance Works

Here is an example of how a merchant cash advance works. 

Example Scenario 1

Restaurant:

Monthly Overall Revenues: $30,000

Avg. Monthly Credit Card Sales: $20,000

The restaurant owner has bad credit, with a 580 credit score. They have been open for two years. Their most recent business tax return shows a loss because of the deductions and deprecation for start-up costs related to opening and operating the business in year one. The bank statements reflect a low average daily balance of $2,500, and there are no other liquid assets to tap into for working capital or cash flow.

Traditional business financing would say no to this restaurant, but merchant cash advance would find this scenario acceptable for offer. The offer would look like the following:

Example 2: Future Receivables Purchase and Sales Agreement (MCA)

Purchase Price (Advance Amount): $20,000

Specified Amount (Payback Amount): $25,600

Specified Percentage (Holdback % of Credit Cards): 14%

Factor Rate (Factor Cost): 1.28

The purchase price, which is the amount advanced to the business, is $20,000. The specified amount, $25,600, is the amount the restaurant will have to pay back over the life of the advance, and the specified percentage is not the interest or factor rate but the percentage of credit card revenues that will be applied to pay back the advance until the specified amount is paid back in full.

The factor cost is $2,560, which is the difference between the purchase price and the specified amount. If you divide the two, the factor rate is 1.28. That’s how you calculate the total cost of a merchant cash advance.

Since there is no set repayment time or principal and interest rate, there is no annual percentage rate. An annual cost of funds calculation is available that annualizes the cost and equates an APR to a merchant cash advance. But, the fact remains that the daily remittance percentage of credit cards and uncertain time of repayment creates inaccuracies in equating an APR.

What Is Needed to Apply for a Merchant Cash Advance For Small Business?

There are only a few documents you may need to apply for and be qualified for a merchant cash advance. These include but are not limited to*:

  • 1-Page Application
  • Business Bank Statements
  • Merchant Processing Statements (if applicable)

*Requirements can vary. Some require only bank statements, but others will require more.

merchant cash advance for small business

Why a Merchant Cash Advance Is a Popular With Small Businesses: Benefits of a Merchant Cash Advance

  1. Remittance is based on business credit and debit card revenue. Taking a percentage of future credit card revenue is attractive to business owners because the payments fluctuate to future sales, protecting the business from paying too much and cutting into profit margins in low sales months. If sales increase, so does the amount to repay, but increased revenue is good.
  2. No term limits. Due to the percentage of future card sales, there is no time frame to repay and payout based on the business's future sales.
  3. No restrictions on the use of funds. Unlike some traditional business loans that ask questions and sometimes want evidence of using the funds, a merchant cash advance does not.
  4. Allows for fair, poor, and bad credit. The way MCA repayment structures work allows for bad credit, unlike traditional business financing, which does not have the risk tolerance for the costs and terms offered.
  5. Cash flow or business bank statement health. Businesses that don’t have much cash flow reserves really appreciate the fact that merchant cash advances allow for low average daily balances in business bank accounts because the payments are taken out of credit card sales transactions and not the business bank account.

Most Common Uses of Merchant Cash Advance

  • Working Capital
  • Improve Cash Flow
  • Purchase New or Used Equipment and/or Software
  • Business Expansion
  • Employee Recruitment
  • Marketing/Advertising for Customer Acquisition
  • Emergencies that Require Financial Aid
  • Purchase Point of Sale Systems

Businesses That Often Use Merchant Cash Advances

  • Restaurants
  • Retail Merchandise Stores
  • Main Street Retail Businesses
  • Auto Repair Shops
  • Hair, Nail Salons & Spas
  • Convenience Stores & Food Markets
  • Any business that accepts credit cards for payment of merchandise or services

What Small Businesses Should Look Out for in a Merchant Cash Advance

  1. Costs. A merchant cash advance costs more than traditional business financing to cover the additional risk involved with lenient restrictions and qualifications.
  2. Payment fluctuation to sales. Payment flexibility goes both ways. If your sales decrease, the payments per month decrease. If your sales rise, so do your payments due to the fixed percentage of future credit card sale deductions for payment. It’s important to be aware of this fact.
  3. Paying off early.  A merchant cash advance does not charge an interest rate or is a flat cost factor, so if you pay off early, it does not function like principal and interest, and you will still be responsible for the full payback amount. There is no benefit to paying off earlier than expected unless a specific early pay discount is built into your merchant cash advance agreement, which some do have.

Alternatives to Merchant Cash Advance Other Than Traditional Small Business Financing

Short-Term Small Business Loan

Short-term business loans are term loans with durations from 6 months up to 36 months. This small business loan features a fixed loan amount, with a set term and fixed payment. The cost is based on an interest rate or factor rate.

Product Overview

  • Rates: Interest rates starting at 9% or Factor rates starting at 1.13%
  • Terms: 6 to 36 months in duration
  • Fees: Lender fees that range from none to 5%
  • Payments: Monthly, Weekly, bi-weekly, or in some cases Monday-Friday, daily
  • Credit Standards: All types are considered

Invoice Factoring

Invoice financing is a purchase of an issued invoice that an issuer can sell to an invoice factoring company for a nominal fee, which in turn will accelerate the collection of invoices and improve cash flow.

Product Overview

  • Rate: None
  • Terms: No term limits
  • Fees: A flat fee that ranges from 1% to 3% of the invoice value. A monthly Service fee also applies and depends on volumes and commitment to the agreement.
  • Credit Standards: The credit of the business owner is not considered.

Purchase Order Financing

Purchase order financing offers businesses the ability to raise capital to pay suppliers upfront for verified purchase orders. Purchase order financing can be structured by financing a portion or the entire order, depending on the scenario. The purchase order financing company pays for the items and collects payment, controlling the entire sales process. The purchase order financing company fees are paid both upfront and through the end users' invoice balances.

Product Overview

  • Rate: None
  • Terms: No term limits
  • Fees: 1% to 3% fee for each purchase order.
  • Credit Standards: All parties need favorable business credit history but all credits considered

Check Out How to Find the Best Small Business Financing Options 

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Jacques Famy Jr

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