What Is a Merchant Cash Advance?
A merchant cash advance (MCA), also known as a purchase of future sales agreement, advances money off of 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 amount and the payback amount. 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. MCA’s 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, and 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 that 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 for approval of an MCA. Business bank account ledgers can be much thinner with lower average daily balances as well. Unlike traditional small business financing, which usually requires at least three years in business, MCA’s can begin to accept applicants with six months in business revenue.
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
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 two years, and their most recent business tax return show’s 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:
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. There is an annual cost of funds calculations 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?
There are only a few documents you may need to apply 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.
Why a Merchant Cash Advance Is a Popular With Small Businesses: Benefits of a Merchant Cash Advance
- Remittance is based on business credit and debit card revenue. The process of 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 margins of profit in low sales months. If sales increase, so does the amount to repay as well, but increased revenue is a good thing.
- No term limits. Due to the percentage of future card sales, there is no time frame to repay and payout based on the future sales of the business.
- No restrictions on the use of funds. Unlike some traditional business loans that ask questions and sometimes want evidence of the use of the funds, a merchant cash advance does not.
- Allows for fair, poor, and bad credit. The way MCA repayment structures work allows for bad credit, unlike traditional business financing that does not have the risk tolerance for the costs and terms that are offered.
- 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
- 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
- Costs. The costs of a merchant cash advance are more than traditional business financing to cover the additional risk that is involved with lenient restrictions and qualifications.
- Payment fluctuation to sales. Payment flexibility goes both ways. If your sales decrease, the payments per month decrease. If your sales rise, so does your payments, due to the fixed percentage of future credit card sale deductions for payment. It’s important to be aware of this fact.
- Paying off early. A merchant cash advance does not charge an interest rate and is a flat cost factor rate, 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 there is a specific early pay discount 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 typically repaid with 6 to 18 months. This small business loan features a lump sum offered up front with a fixed payback amount calculated using a factor rate.
Rates: Factor rates range from 1.09% up to 1.45%
Terms: 6 to 18 months in duration (typically 12 months or less)
Fees: 0% to 5% origination fees
Payments: Weekly, bi-weekly and in some cases daily
Credit Standards: All types considered
Invoice financing advances the outstanding balance to a business owner to increase the speed of cash flow to the business. This solution provides cash quickly, and there is no need to wait for outstanding invoices to be collected. Invoice financing has affordable costs ranging from 1% to 2.5% fee off of the face value of the invoice advanced.
Terms: No term limits
Fees: 1% to 3% fee based on the invoice. Monthly Service fees may apply
Credit Standards: Credit of the clients need to be favorable NOT the business owner
Purchase Order Financing
Purchase order financing offers businesses the ability to raise capital to pay suppliers upfront for verified purchase orders. Purchase order loans will finance an entire order or a portion of it, depending on the purchase order funder. When the supplier is ready to ship the order, the purchase order financing company collects payment directly from the customer. The purchase order funder will subtract their fees and then send the invoice balance to your business.
Terms: No term limits
Fees: 1% to 3% fee for each purchase order.
Credit Standards: All parties need favorable business credit history but all credit considered
Check Out How to Find the Best Small Business Financing Options and Weigh All the Benefits of Getting Funding for Your Business
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