Merchant Cash Advance

What is a Merchant Cash Advance & Why is Invoice Factoring a Better Option?

To explain it as simply as possible, a Merchant Cash Advance (MCA) is when you receive money from a financial services company and pay that money back using future credit card sales.

This method is often used as a financing option by retail businesses, restaurants and service companies in San Diego that have strong credit card sales but cannot qualify for conventional loans.

MCAs are used as start-up financing, business asset financing or purchase order financing by businesses in San Diego.

Initially, the concept of an MCA was prepared as a onetime payment to a business in exchange for an agreed upon percentage of future credit/debit card sales. Today, it is frequently used to provide small businesses financing options that have short-term and small regular payments compared to conventional bank loans.

Usually, there is a partnership established between financial service companies that provide MCAs and credit/debit card payment processors to enable payments to be taken directly from the credit/debit processor on a daily basis until the obligation has been fully paid.

How does a Merchant Cash Advance Work?

The payments for an MCA will be taken from an agreed upon percent of future credit/debit card sales until the amount advanced to the business (plus interest) is fully paid.

The provider uses factoring services wherein the fees are computed at a rate of 1.14 to 1.48 multiplied by the amount of money received. The result will be the total amount that a borrower has to pay back.

A San Diego accountant and columnist for the American Institute of Certified Public Accountants, Leonard C. Wright, a.k.a “Money Doctor” says that interest rates for MCAs can actually range from 60% to 200% Annual Percentage Rate.

COST COMPUTATION

Amount Advanced From Provider: $20,000
Money Factor used by Provider to calculate fee: x      1.4
Total amount to be repaid: $28,000

Example:

If you were to borrow $20,000 and repay it over a 12 month period with a money factor of 1.4, the total you would end up paying back would be $28,000. This is 40% of the amount borrowed. Considering the average balance of money borrowed is $10,000 over the course of the 12 month time period (because it starts at $20,000 and ends at zero), that means you’re paying $8,000 on an average $10,000 balance, or 80%.

What are the Advantages of MCA?

  • There’s little paperwork required (Usually, all that is required is the application, government-issued ID and a few months of business bank statements. Some providers require other documentation.)

  • High approval rates

  • Fast way (usually less than a week) to get liquid cash. This gives business owners the opportunity to procure supplies, pay debts, salaries, etc.

  • Can be procured even with bad credit or limited business history

  • No upfront collateral needed (The provider does take a lien on most, if not all, of the assets of the borrower. High value assets are not a requirement though).

  • Minimum monthly installments are not imposed

  • You are not restricted on where your cash can be used

  • You pay the advance on agreed upon percentage of credit/debit card sales. Thus, if sales are low during an off season, the borrower will have the flexibility of managing his cash flow. This is because the amount you pay will depend only on the cash flow or sales for the day.

What are the Disadvantages of MCA?

  • Higher costs compared to traditional loans.

  • Because an MCA comes with a fee rather than an interest rate, you will be required to pay the fee in full regardless of how quickly you pay back the money. (Example: If you receive a $20,000 loan from a bank and you pay it back one month later, you will only be required to pay a little over $20,000 because not much interest would build up in a month. If you get an MCA for $20,000 and you find that you are able to pay it back in one month, you will still be required to pay the full $28,000 because the MCA does not work on interest, the $8,000 is a “baked in” fee that must be paid in full.)

  • Less flexible at a very short time frame. Usually 3 to 18 months at the most.

  • Reduces cash flow due to daily payments of credit/debit card sales

  • It may not solve your problem if used incorrectly. Again, it may not be a loan but it functions like a loan. After release of the advanced amount, the payments are taken regularly, often on a daily basis.

  • Selling future sales is risky, since no one can predict the future. An MCA can address a current need but if future sales are extremely low, you might end up in need of additional cash once again to keep the business afloat.

Payment Methods

Payment can actually be divided into three different methods:

Split Withholding

The most preferred method for both parties, split withholding is when the credit card company automatically deducts the sales based on the agreed percentage rate.

Automatic Clearing House (ACH) Withholding

This is where the provider receives the card processing information and directly deducts the agreed percentage portion from the checking account of the business through ACH. This is if it is structured as a sale. If it is structured as a loan, the provider charges a fixed amount on a daily basis, regardless of sales.

Trust Bank Account Withholding or Lock Box

This is when the finance company requires the business owner to deposit all credit/debit card sales into a bank account controlled by the provider. The agreed percentage rate is then deducted and the remaining amount is forwarded to the business thru EFT, ACH, or wire transfer. It takes a one day delay for the business to receive the proceeds of their credit/debit sales.

Why Invoice Factoring is a Much Better Option for Your Business

Although an MCA requires a minimal number of documents from the applicant, invoice factoring involves nothing but the invoice to achieve financing for your business.

You can actually get the finances that your business needs in a much shorter time and with even less hassle. As long as a business owner has invoices for receivables financing, you’ll be cash ready in no time.

With invoice factoring, you simply sell your outstanding invoices to a factor and let them do the collecting for you while you run your business. The factor gets paid back when they collect on the invoices they have purchased from a business, making the whole process much simpler than MCAs.

Seek Financial Advice from a Licensed Professional

Before seeking a Merchant Cash Advance or Invoice Factoring, business owners should seek financial advice from a Certified Public Accountant to make sure if it’s necessary and also to ensure you have the capacity to pay. Implementing an effective Accounts Receivable Management policy will greatly increase the success rate of your business.