Working Capital

Traditionally, Merchant cash advance works like this:

• MCA’s finance company provides cash in lump sum against your future sales.
• You pay back this fund and fees as a percentage of your daily (or weekly) debit and credit card sales.
• Payments will be automatically deducted from your merchant account/business bank account until you repay the full amount and fees.

Unlike most other types of business loans, merchant cash advances have no annual rate or repayment terms.

MCA’s are typically used by businesses that rely on debit and credit card sales, such as restaurants, bars, retail stores, and salons, to profit from those sales. However, some lenders collect repayments directly from your bank account (rather than the merchant’s account). This means that even businesses that don’t rely heavily on selling debit or credit cards can take advantage of this type of financing. In this case, the process works essentially the same, except the merchant cash advance company connects to the bank account and uses ACH withdrawals to collect repayments and fees.

MCA providers can be connected to bank accounts or merchant service providers so merchant cash advances are easily accessible and funded quickly. However, they are he one of the most expensive loan products on the market.

As mentioned earlier, merchant cash advances are expensive. Therefore, it is important to understand how MCA finance companies charge their fees. Just as MCAs are structured differently than most business loans, so is the way interest is charged on this loan product.

Merchant cash advance financing companies measure fees using factor rates, also known as factor fees, instead of interest rates. The factor rate you receive for your MCA is based on your company’s assessment of your qualifications. Factor sets typically range from about 1.10 to 1.50+.

Similar to traditional interest rates, the higher the factor rate, the higher the fees you will have to pay and the higher the cost of your merchant cash advance loan. Generally, when factor rates are converted to APR, rates start at 15% and can exceed 100%.

It is also important to note that some MCA funding companies charge additional fees. In most cases, you’ll see an “administration fee” that you’ll be charged to set up your account. Before agreeing to merchant cash advance, make sure you understand all costs of merchant cash advance.

While traditional business loans have a fixed repayment period (for example, if the loan is paid off in monthly payments over five years), cash advance terms don’t work the same for merchants.

As mentioned earlier, money borrowed from MCA is repaid through debit or credit card sales or withdrawals from bank accounts. In most cases these payments are made daily, but some companies may offer weekly payments.

Since payback is based on sales, MCA terms vary. In other words, we will reimburse your prepayment for as long as it takes to cover the total amount received plus fees.

Overall, the average repayment period for merchant cash advances is 12 months. However, the term may be as short as 4 months and as long as 36 months. Everything depends on your business. Up to this point, paying a fixed percentage of sales to finance companies means shorter payback periods, but also tighter cash flow.

This is an example of how merchant cash advance works. Perhaps more important is the cost of MCA.

Suppose you receive $20,000 from a financial company to finance the renovation of a retail store. The financial company charges you a factor rate of 1.18.

$20,000 multiplied by 1.18 for you equals $23,600. This is the total amount you have to pay back in your daily debt and credit card transactions.

The merchant’s finance company charges 15% of the credit card transaction to cover this amount. The actual amount you pay each day depends on your sales. The higher your turnover, the faster you can pay your advances.

For example, let’s say you estimate your credit card sales to be $25,000 per month. Dividing $25,000 by 30 days in a month yields approximately $833 per day. That means you pay $125 every day, or 15% of $833.

At $125 a day, it would take 189 days (about 6 months) to pay off the total $23,600. $125 a day may not seem like much, but the APR for this merchant cash advance loan is almost 66%, which is a very high value.

This is why MCA can be so misleading. At first glance, the numbers look reasonable and the coefficient of 1.18 seems low. However, when calculating his APR for these instruments, they are often very expensive, especially when compared to other types of business finance.

For this reason, before agreeing to a merchant cash advance from a financial company, always convert the factor rate into APR to determine the true cost of that debt and whether you can afford to pay it or not.

At this point, you may have started to see some of the unique strengths and weaknesses of merchant Cash Advance. So let’s analyze these pros and cons in more detail to help you decide if this type of financing is right for your business.

• Fast access to funds: After all, merchant cash advances are one of the easiest ways to fund your business. Typically, you can apply for an MCA online and get approval and funding in as little as 24 hours. Compared to other loans that require extensive documentation, MCA’s application process is very simple.
• Easy approval process: Not only is the process itself straightforward, MCA is one of the easiest financial products to qualify for. MCA companies often pull your credit score to assess other qualifications. However, it is much more permissive when it comes to approval. Many financial firms work with startups, companies with poor credit ratings, and companies that have had previous financial troubles. Of course, your eligibility not only affects your ability to get a merchant cash advance loan, but it also affects your interest rates.
• Suitable for various business purposes: Overall, merchant cash advances can be used to fund basically any business purpose. MCA can be used for working capital, inventory purchases, payroll payments, or other similar short-term expenses.
• Repayment based on your sales: While traditional business loan repayments are constant regardless of company performance, MCA payments vary based on company earnings. When your business is in a slump, pay less daily or weekly. For this reason, MCA is commonly used in seasonal stores, retail stores, and restaurants.

• Fees are higher than most other loans: We can’t stress this enough – ultimately, a merchant cash advance will be one of the most expensive forms of business funding. While the rate and terms of the MCA seem reasonable, when you take a closer look (and calculate the APR), you’ll find that it’s significantly higher than for any other type of funding. Also, as mentioned above, although less qualified businesses may be approved for MCA, they will face the highest interest rates, making it difficult to pay back the principal. that they borrowed.
• Deducting daily credit card sales reduces cash flow: Again, while one of the benefits of a merchant cash advance is that payments vary based on your sales, the actual structure of an MCA makes it difficult for businesses to cash flow. Since you repay your MCA regularly and directly from domestic sales, this type of financing has a significant impact on your cash flow. Also, because of the way merchant cash advances work, there’s no benefit to prepaying your loan, a benefit of many other types of business financing.
• Getting caught up in debt: As you may have deduced based on our last two points, it’s very easy to fall into debt when you cash advance a seller. If you’re a shoddy business in need of funding, an MCA might seem like your only option, but with high fees deducted directly from your cash flow, it can be difficult to get a refund. As a result, many borrowers attempt to refinance or add another MCA, which only leads to financial problems and risk of default.
• Confusing contracts and few provisions: Another common problem with MCAs is that because of the way they are structured (with factor ratios, daily sales percentages, and no specific terms), their contracts can be extremely confusing and Business owners can sign them to receive money quickly without fully understanding the agreement. . In addition, because merchant cash advances are not technically loans, they are not subject to the same regulations as other types of business financing. Historically, this has caused businesses to fall victim to deceptive sales and advertising tactics, especially from merchant cash advance brokers who approach them promising Fast and easy funding approval.