Definition of Merchant Cash Advance (MCA)
A merchant cash advance for businesses is an alternative to a traditional loan and provides quick cash against future credit card sales and a fee.
A merchant business cash advance is often taken as a shortcut by small business owners due to easy credit requirements and quick loan disbursal.
Merchant Cash Advance (MCA), as a business financing option for small business owners, is not a loan in the conventional sense but rather a business cash advance based on the future credit card sales or receivables of a business.
A merchant cash advance is one of the types of business cash advances.
A business cash advance is when you take a lump sum payment against future receivables or sales of the company, and payback is based on a fixed percentage of future sales.
Following are the ways for a small business to raise funding on an immediate basis:
- Merchant cash advance
- Factoring or invoice financing
- Bank Overdraft
- Term loans
- Asset-based loans
- Business lines of credit
Being one of the types of business cash advances, in MCA, the borrower receives a lump sum of capital upfront and agrees to repay this amount, plus fees, from a portion of its daily credit card sales. This financial solution is particularly suitable for businesses with high credit card transaction volumes and those seeking fast funding without the stringent requirements of traditional loans.
Why do small businesses go for MCA?
Often, small businesses need a merchant cash advance for the following reasons:
- Due to a poor business credit history, a small business may be unable to raise finance from traditional sources and thus opt for MCA.
- Raising a small business loan could be difficult due to a lack of matching collateral. Meanwhile, a business cash advance is unsecured or without any significant collateral.
- Due to irregular cash flows, making fixed payments can be difficult for a small business. Instead, the merchant cash advance provider takes payment as a percentage of daily credit card sales, thereby eliminating fixed payments.
- An urgent need for a cash advance to meet either a shortage in working capital or to meet a sudden surge in demand needs quick access to a business cash advance.
- Due to irregular revenue streams, the business may not wish to opt for financing options, having fixed payments for a long time.
How does Merchant Cash Advance (MCA) work?
A merchant cash advance operates on a different principle than conventional small business loans. Loans are secured and collateral-based, while MCAs are unsecured and are given on the basis of a company’s future receivables.
Before making an upfront business cash advance offer, a merchant cash advance provider assesses a company’s credit card processing statements to anticipate the amount of future sales and credit card payments.
A portion of each day’s credit card receipts is automatically sent to the business credit profile lender, and the repayment is contingent upon the business’s future sales. Because the amount repaid each day varies based on the business’s sales volume, this repayment structure gives businesses flexibility.
A company makes larger repayments during times of strong sales, and smaller repayments during slower times. As a result, the payment is modified in line with shifting sales or business cycle changes.
The total amount owed on business cash advances is calculated using a factor rate rather than an interest rate. The factor rate, which usually falls between 1.1 and 1.5, aids in figuring out the total amount owed.
Understanding Merchant Cash Advance Terms and Conditions
Criteria for Merchant Cash Advance
The criteria for merchant cash advances usually include a minimum threshold of monthly credit card sales and a certain period of business operation.
Providers may also review your business’ bank statements, account statements, and credit card processing statements to assess your business’s cash flow stability and sales consistency.
To gauge the repayment of bad credit behaviors, they may also look for your credit score too.
MCA Factor Rate
MCAs use factor rates to determine the total repayment amount. This rate, usually ranging between 1.1 and 1.5, is multiplied by the cash advance amount to calculate the total amount due.
Cash Advance Limit
The cash advance limit is the maximum amount a business’s bank account can receive from an MCA provider. This limit is typically based on the business’s average monthly credit card sales.
Providers assess your past sales to estimate future revenue, determining the advance amount they are willing to offer.
It’s important to understand this limit to ensure that the advance meets your financial needs without overburdening your small business funding amount with debt.
Repayment Terms
MCA repayments are usually made daily or weekly as a percentage of your credit card sales, providing flexibility that aligns with your business’s cash flow. Understanding these terms, including the percentage rate and how it’s applied, is crucial for managing your finances effectively.
Usually, the payment term for a business cash advance, in this scenario, ranges from 4 months to 1 year.
Additional fees
Be aware of any additional fees associated with the MCA, such as origination fees or processing fees. These can add to the cost of the advance and should be considered when calculating the total repayment amount.
Early Repayment Policies
Some MCA agreements may include policies or penalties for early repayment. Understanding these terms can help you manage your finances better and potentially save on costs if you’re able to make flexible payments to repay the advance ahead of schedule.
Benefits of Merchant Cash Advances for a Small Business
- Quick Access to Funds: MCAs often provide fast funding, sometimes within 24 hours.
- Minimal Credit Requirements: Merchant cash advances are issued based on anticipated daily credit card sales and not credit scores.
- Flexible Repayment Terms: Repayments are based on a percentage of daily credit card sales, making them more adaptable to the business’s cash flow, especially during slower sales periods.
- No Collateral Required: MCAs are unsecured, meaning business owners don’t need to put up personal or business assets as collateral.
- High Approval Rates: Businesses with strong credit card sales but less impressive credit profiles may find it easier to get approved for an MCA than for a traditional bank loan.
- Building business credit history: Many MCA providers report to business credit bureaus. In case you are making on-time payments, then you can build your credit history.
- Not hitting the credit score: There are no hard inquiries from the business cash advance providers. Thus, it does not impact the credit score.
Drawbacks of Merchant Cash Advances
- Higher Costs: MCAs can have higher costs compared to traditional loans, often reflected in higher factor rates and additional fees.
- Impact on Cash Flow: Daily deductions from credit card sales can strain a business’s cash flow, especially if sales do not meet projections.
- Less Regulation: The MCA industry is not as heavily regulated as traditional banking, which can lead to less transparent terms and higher costs.
- Potential for Debt Cycle: The ease of access to funds can lead businesses to rely on MCAs repeatedly, potentially leading to a cycle of debt.
- No Benefit from Early Repayment: With MCAs, the total payback amount typically remains the same regardless of how quickly the advance is repaid.
Comparing Merchant Cash Advance with Other Financing Options
Merchant Cash Advance vs. Traditional Bank Loans
| Points of Difference | Traditional Bank Loans | Merchant Cash Advance |
|---|---|---|
| Approval Process | More stringent approval process, requiring higher credit scores and collateral. | Based on future credit card sales, easy approval, and does not require any credit score and collateral. |
| Repayment Terms | Bank loans typically have fixed monthly payments. | Merchant cash advance has flexible repayments based on daily credit card sales. |
| Funding Speed | Often the lengthy process of securing loans. | Quicker access to funds, usually within a day. |
| Interest Rates | Loans usually offer lower interest rates and are more cost-effective options in the long term. | Factor rates are higher than the loan interest rates. |
Merchant Cash Advance vs. Small Business Loans
| Points of Difference | Merchant Cash Advance | Small Business Loans |
|---|---|---|
| Credit Score Requirements | MCAs are accessible to businesses with a range of credit scores. | Small business loans usually demand higher credit scores |
| Usage Restrictions | MCAs offer more flexibility in how the funds are used. | Small business loans may have specific usage conditions. |
| Repayment Terms | Flexible and dynamic repayment based on the level of periodic sales. | Small business loans have a fixed repayment schedule. |
Merchant Cash Advance vs. Revolving Credit Lines
| Points of Difference | Merchant Cash Advance | Revolving Credit Line |
|---|---|---|
| Continuous Access to Capital | MCAs have a one-time lump sum payment. | Revolving credit lines, like business credit cards, provide ongoing funding. |
| Cost of Borrowing | High factor rates | Interest rates for revolving credit are generally more favorable. |
| Repayment Flexibility | MCA repayment is based on sales volume and is more dynamic. | Revolving credit lines offer flexible repayment options but don’t adjust to sales volume. |
Merchant Cash Advance vs. Invoice Factoring
| Points of Difference | Merchant Cash Advance | Invoice Factoring |
|---|---|---|
| Collateral Requirements | MCAs are unsecured advances based on future credit card sales. | Invoice factoring requires outstanding invoices as collateral. |
| Dependency on Receivables | MCAs are unsecured advances based on future credit card sales. | Invoice factoring is dependent on customer payments. |
| Target Business Type | MCAs suit retail or service businesses with high credit card sales volume. | Invoice factoring is ideal for B2B companies with invoice-based sales. |
Merchant Cash Advances: Secured or Unsecured
MCAs are unsecured forms of financing that do not require any collateral to be given.
To mitigate the lending risk, the MCAs rely on future credit/ debit card sales as a means to pay back from the sale proceeds or receivables.
Due to the focus on future sales receivables, the business owner does not need to mortgage or keep collateral for his business and personal assets, and there is no usage of credit scores either.
A business owner or a startup may not have a substantial asset to offer as collateral to get a traditional loan thereby even the genuine borrower also gets sidelined.
The unsecured loan feature of MCAs attracts small business owners who can repay the business cash advance, but cannot acquire it through mainstream channels.
Why is an MCA (Merchant Cash Advance) not a loan?
A merchant cash advance is not a traditional business loan.
A traditional small business loan will include a fixed interest rate and fixed payment schedule and is normally issued against collateral.
An MCA has a factoring rate, also called a withholding rate, where the borrower has to keep aside a percentage of future credit card sales for repayment of business cash advance. In one sense, it makes it very dynamic as payments are related to sales and are not fixed.
In MCA, the future income is the collateral; in the case of a bank loan, the collateral exists and has a value.
In a bank loan, the interest accumulates over time, while in MCA, the factor rate is applied to future income and has a fixed percentage of it to be paid to repay the advance.
In bank loans, there are fixed, regular payments irrespective of business income. In the case of MCA, the payment fluctuates with the income.
Can a merchant cash advance hurt your credit?
Merchant cash advances are not dependent on credit score as in the case of traditional loans. So, there is no case of any hard inquiry that can impact your credit score. Rather a person with low credit score can also get business cash advance if there are promise of future receivables.
Failure to repay may not impact credit scores (FICO Score), but in the event of a lawsuit to recover missed payments or any unpaid amount, it can surely impact adversely.
When the repayment of business cash advances works by withholding a percentage of daily credit card sales, it narrows down the cash flow available for business operations, expansion, etc. In case the projected sales are not met, then there is a threat of default on other financial obligations, too.
It could negatively impact cash flow problems and the business credit bureaus’ assessment of the business’s creditworthiness.
An over-reliance on MCA can snowball into debt and can mount a very high factoring rate or fee, which a small business must pay, or it could result in legal proceedings.
Impact of merchant cash advance on taxes
The amount received from MCA is not treated as income; it is neither taxed nor reported on the tax return.
MCA not being a loan but an advance on future income; thus, instead of treating as a debt, it is considered as a business transaction.
The fees or factor rates associated with the MCA can often be deducted as a business expense. This deduction can slightly offset the overall tax burden, as these fees effectively reduce the business’s taxable income.
The primary tax consideration for an MCA lies in its repayment. The portion of sales used to repay the MCA is still considered revenue and is, therefore, taxable.
Business owners must maintain accurate records of their MCA transactions, including the advance amount, daily credit card receipts, payment history, and the total amount repaid, including fees.
The records are essential for accurate tax reporting and can help ensure that the business takes full advantage of any available deductions related to the MCA.
Factors to consider when choosing merchant cash advance providers
- Reputation and Credibility: Must research the credibility, ratings, and feedback of a potential business cash advance provider. Reputation can be measured by positive reviews, customer feedback, referrals, recommendations, testimonials, etc.
- Terms and Conditions: Carefully read the terms and conditions, especially the factor rate or withholding amount, repayment terms, additional fees, penalties, or actions in case of delayed payments, etc. Discuss your repayment capacity much in advance before you negotiate for the factor rate.
- Advance Amount and Repayment Structure: Evaluate the right amount of money or capital infusion you need and have a proper commercial justification for it. Insufficient amounts at stringent payment terms will hurt business more than anything else. Understand the workings of the payment structure, too.
- Flexibility and Transparency: Look for providers who offer flexibility in repayment and are transparent about the processes.
- Speed of Funding: Consider how quickly providers can process your application and deposit funds into your business bank account.
- Collection Method: Most merchant cash advance providers deduct a percentage from daily credit card sales, but terms can vary. Ensure their collection method is convenient and doesn’t disrupt your business operations.
- Eligibility Requirements: Check the eligibility criteria, including minimum monthly credit card sales and business operation duration. Ensure your business meets these requirements before applying.
Conclusion
Merchant Cash Advances offers a flexible and accessible financing option for small businesses, especially those with high credit card sales volumes. While they provide quick funding and adaptable repayment terms, it’s crucial for small business owners to carefully consider the costs, impact on cash flow, and terms offered by providers to ensure this financial solution aligns with their small business financing needs and goals.
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