What is a merchant cash advance? Here’s what entrepreneurs should know

What is a merchant cash advance

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Maintaining steady cash flow can be a challenge, especially for businesses that primarily rely on credit or debit card sales. You also might be considering financing options to keep your operations running smoothly through slower times. You also may have heard of a merchant cash advance (MCA), but what is a merchant cash advance, and how does it work?

What is a merchant cash advance?

Unlike traditional business loans, MCAs offer a unique approach to financing: They allow businesses to receive an upfront sum of money (the “cash advance”) which is then remitted either daily or weekly to the MCA provider. The remittance amount is equal to a specified percentage of future credit or debit card sales.

“This setup can be particularly appealing for businesses experiencing a slow season or a disruption in their normal sales cycle. MCAs provide the necessary funds to cover immediate expenses without the stringent requirements and lengthy approval processes associated with conventional loans,” said Credibly Founder Ryan Rosett.

In this blog post, we’ll go into the specifics of MCAs, including remittance terms to look out for, and rates and fees for MCAs. We’ll also review the pros and cons of MCAs, the consequences of defaulting (and what you can do to avoid this), and how you can access expert insights to help you decide if an MCA is a good fit for your business.

Tip: Businesses considering an MCA should weigh the fast access to cash against the potential impact on their profitability and the cost of borrowing.

Remittance vs. loan repayment

Remittance and payments are terms often used when discussing the transfer of money, but they serve different purposes in a commercial setting.

Payment refers to any transfer of money that occurs when two parties are involved in buying or selling a product or service.

Remittance, however, is a specific type of payment. It’s used to describe money sent to fulfill a particular need or obligation.

MCA terms

Unlike fixed monthly payments, MCAs are remitted through a portion of the business’s daily credit or debit card sales. This method can be more manageable for businesses with fluctuating revenues.

There are a few main ways you can remit your MCA:

  • Split withholding: This method involves the credit card processor dividing the day’s sales between the business and the MCA provider. A predetermined percentage of daily sales goes directly to the provider, making this method directly proportional to the business’s income. This offers flexibility during slower sales periods.
  • Automatic clearing house (ACH) withdrawals: This is a direct debit from the business’s checking account, where the MCA provider deducts a predetermined amount regularly based on a good faith estimate of the anticipated receivables based on prior months’ activity.This method  provides for a consistent remittance schedule. If the actual debited amount exceeds the specified percentage of the receivables, you can have any overage credited to your account at the end of each month through a process called “reconciliation.”
  • Lockbox or bank withholding: Under this arrangement, the business’s credit card sales are deposited into a bank. The bank then splits these transactions, sending a portion to the MCA provider and the remainder to the business’s account.

Ways to manage your business loan or financing

If you have additional an additional loan or form of financing, here are some tips to manage payments:

  • Incorporate the monthly loan payment into your business budget immediately after signing the loan agreement. Prioritize this payment over non-essential expenses.
  • Paying more than the minimum amount on your loan or financing can save you money on interest and shorten the loan term.
  • Regularly review your business’s cash flow. Adjust your budget based on actual monthly revenue, which can fluctuate.
Learn more about your business financing options:

Rates and fees for MCAs

MCAs use “factor rates” to show the total cost of the advance (excluding certain fees).

A factor rate is a decimal figure that, when multiplied by the advance amount, determines the total amount you will remit. For instance, if a business receives an advance of $100,000 with a factor rate of 1.2, the total cost of the financing will be $120,000.

In addition to the factor rate, businesses must also consider the different fees associated with MCAs. These can include underwriting fees which cover the cost of evaluating and approving the advance, and administrative fees which are for managing the account and reconciliation process.

These fees add to the total cost of the advance, making the actual cost higher than the factor rate alone suggests.
 

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The pros and cons of MCAs

MCAs offer a blend of advantages and challenges for small businesses seeking quick access to capital. Here’s an overview of the pros and cons.

Pros

  • Fast access to cash: MCAs provide rapid funding, often within a few hours or days, making them ideal for urgent financial needs.
  • Flexible requirements and remittance schedule: With eligibility criteria focused on cash flow, MCAs offer flexible remittance terms that adjust to sales volume, ensuring businesses like yours aren’t overwhelmed during slow periods.
  • Flexibility in use of funds: Businesses can use MCA funds for a wide range of purposes, from inventory purchase to marketing, without restrictions imposed by
  • loans or other financing products.

Cons

  • High costs: MCAs can be significantly more expensive than traditional loans
  • Impact on cash flow: Fixed daily or weekly remittances can strain cash flow, especially during periods of reduced sales.
  • Does not build credit: Payments towards MCAs are generally not reported to credit bureaus. This means you could be missing out on an opportunity to build or improve your business’s credit score.
  • Potential for debt cycle: Relying on multiple MCAs to solve financial issues can lead to a cycle of debt, as you might struggle to manage remittances and operational costs simultaneously.

While MCAs offer a quick and accessible financing option for businesses in need, the high costs and potential impact on cash flow require careful consideration.

If you’re uncertain whether an MCA is the right fit for your business, this is where Credibly steps in.

 

Unsure if an MCA is the best fit for your business?

We’re here to help.

With our expertise and flexible financing solutions, we’re here to guide you through the decision-making process.

Don’t let financing be a barrier to your business’s success.

Contact Credibly today to learn more about how we can help you access the capital you need, when you need it.

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