A merchant cash advance is a lump sum amount of cash that a business gets in exchange for selling a fixed dollar amount of business’ future receivables. The concept behind a merchant cash advance is that you can sell the future sales of your business and get funded quickly. With this short-term funding solution, the repayment typically happens in months.
Merchant cash advances are especially made to support the financing requirements of small businesses with a high level of credit and debit card receipts. Restaurants and retail businesses are the common types of businesses that use merchant cash advances.
How Do Merchant Cash Advances Work?
Most lenders consider their transactions to be a purchase of future sales rather than a loan. In order to determine how much cash to provide your business, lenders evaluate your credit card sales, business sales, bank statements, and some other business related information. These financial reports provide them with sales performance information of a business, which provides them a picture of your potential sales.
How Is Cash Advance Calculated?
The cash advance lender determines how much amount of cash to advance your small business by evaluating previous sales of your business. The cash advance lender evaluates previous credit card transactions and also evaluates your business bank statements.
Most cash advance lenders normally fund almost 80-150% of the average monthly sales of your business. This amount varies by lender and is also based on the financial strength of your small business.
What Are The Positives Of MCA?
According to BusinessWeek, there is no need for a small business to go through a lengthy loan application process to get a merchant cash advance and receives funding in a week or even less. Many cash advance lenders will lend to people with bad FICO scores, sometimes they will lend to people with credit score in 400s range. As the repayment of a cash advance is solely based on the sales of your small business, businesses normally have an easier time servicing their obligations as compared to a business loan.
What Are The Negatives Of MCA?
Merchant cash advance is the most expensive way to finance a business. As the cash advances are normally repaid in a year, the APR on purchase frequently goes into the triple-digit figure. With interest rate that high, the small business owner may additionally have a difficult time in paying back the cash advance. Additionally, there are some businesses that get cash advances without thoroughly reading and evaluating the terms of the merchant cash advance and that is why cash advance could cost them even more than they normally can manage.
Merchant Cash Advances Versus Traditional Business Loans
The major difference between the traditional business loans and alternative funding options is the availability: Approval rates for alternative funding sources are higher than traditional bank loans, and many small businesses that don’t make the grade for a traditional bank loan can get a merchant cash advance. Here is a comparison of some major differences:
|Merchant Cash Advance||Traditional Bank Loan|
|Approval is based on ability to repay, not personal credit history||Approval is based largely on personal credit score|
|No collateral requirement||Borrower usually has to supply personal assets as collateral|
|A flat-fee premium is added to the borrowed amount||Interest charges are charged over time|
|Variable payment amount; tracks the original sales volume||Fixed payment amount|
|Adjustable repayment terms based on credit card sales||Fixed repayment term|
|Quick approval process, funding in a couple of days||Approval and funding may takes weeks or even months|
How The Payback Amount Is Calculated?
The repaid amount ranges from 9-50% more than the funded amount. The lenders usually refer this to as a factor that is usually between 1.09 and 1.50. The cash advance repayment is determined by multiplying the factor by the given advanced amount. For instance, $100,000 of cash advance with a factor of 1.35 requires a payback of $135,000. If that is the case, you pay off 35% more than the advanced amount.
Normally, most merchant cash advance transactions are short-term, almost 3-15 months. To determine the APR of the cash advance transaction, you have to consider both the cash advance factor and also the repayment term of cash advance. As you can consider, the annual percentage rate is much higher than an average small business loan.