Both cash advances and business loans are funding sources that can provide small businesses with liquidity to sustain their operations in a time of crisis. While either of these products may be a good financing option, the structure of these borrowing methods is very different.
Merchant Cash advances
Business loans and cash advances help enterprises expand operations, acquire equipment, manage wages, solve seasonal problems, and more. Although both of these options can be used for one purpose, there are many differences between them, including the repayment terms, cost of financing and qualifications.
Working of Merchant Cash Advances
A merchant cash advance is more of an advance on future sales by credit card. Cash advance merchant providers buy your future credit card receivable amounts at a discount and you have to pay a factor rate instead of an interest rate to the MCA provider.
The provider pays you a one-time as a prepayment, which you pay with a daily credit card percentage. Although there is a fixed ratio, the amount you pay daily is variable. Due to the variable term, usually from four to eighteen months, the annual percentage rate can vary widely – usually from 80% to 120%.
As a rule, when you receive an advance from the seller, you can get financing within one to three days.
Advantage of a cash advance
Cash advances are a great solution for businesses with less stable cash flows because payments are always based on what you can afford. For seasonal businesses, fixed-term loan repayments can be difficult in slower months. Since cash advance payments are transferred from future receivables, enterprises can take loans with confidence, knowing that their obligations will never exceed revenue.
While this is a good example of when a cash advance payment is a good option, it is important to evaluate your specific qualifications and needs before deciding which option is best for your business.
How to determine if a cash advance is right for you?
Understanding how business advance funding works is important to determine if it is right for your business. If you have a seasonal business, a cash advance to the merchant may be useful to you, although business loans, in general, will cost less.
Is a merchant cash advance a good option?
Cash advance payments are a good choice if you do not want your credit report to be put forward, you have a seasonal business or you are an online seller. Due to the relatively high cost of the MCA, you will need to evaluate other alternatives before deciding whether to accept a cash advance.
Merchant Cash Advance Qualification
- Qualifications for cash advances and loans are very different. MCA qualifications are largely focused on your credit card sales, while business loan qualifications are focused on your total business income. Both commercial cash advances and business loans are generally easier to obtain than other working capital loans.
- Cash advance qualifications are mainly related to the company’s credit card sales. This all happens because MCAs are based on the company’s annual sales of credit cards and are repaid to use a percentage of your company’s credit card daily receipts. The creditworthiness of the business owner is also taken into account.
- To receive a cash advance, as a merchant, you need to for having an account with the verified credit card processors. According to the MCA providers and their agreements, this may mean that you need to change your credit card company.
- MCA payments are charged directly from your daily credit card sales, and as these sales fluctuate, the actual term of the reseller’s down payment is variable. This results in a typical calculated APR of between 80% and 120%. Remember, however, that this rate is maintained and your actual cost of capital depends on the factor rate.
- Depending on the merchant cash advance provider you have chosen, there may be other payments related to the advance payment of the seller’s cash. Some providers charge shipping fees ranging from 1% to 5% of the advance amount.
- The most important costs associated with the advance payment of the seller’s cash are the factor ratio and retention rate. The factor ratio is the total amount of capital that you will have to pay off to the supplier, and the retention percentage is the percentage of daily sales on credit cards that the provider collects until the factoring percentage has been fully paid off.
Cash advance payment is probably the best option in these three scenarios:
1. You do not want a loan on your credit report
If you are trying to recover your loan or are planning a major purchase, you probably do not want the business loan to appear in your credit report. The seller’s cash advance is usually not shown in your credit report.
2. You do seasonal business
Due to repayment conditions, cash advance payment is a good option for seasonal businesses. This is due to the fact that the amount of the monthly payment is less when the business brings less income and increases when the business receives more income. This is in contrast to all types of business loans, which recorded monthly payments regardless of business performance.
3. You are an Internet seller
The majority of online stores and other companies that are spending most of their online sales are the main candidates for cash advances. Just because of all businesses of this type of receive payments primarily through credit card purchases, so they will be able to receive a high down payment in exchange for part of their daily credit card receipts.
Companies that go through the financial difficulties are denied loans and resort to cash advances in the hope of a quick infusion of funds. Cash advances have the less strict qualifications and are obtained easily. If you are running a seasonal business or you have a large volume of credit card transactions, a cash advance payment of the seller may be suitable for you.
Image Credits: Nikolay Frolochkin