Merchant cash advances have been a crucial funding solution for many small businesses. It has been supporting SMEs around the world by injecting cash into the business when the cash flow statements looked dire.
Smooth flowing working capital is crucial for any business. Whether or not the business is making a profit is a secondary question. It is pertinent that the business meets its fixed costs such as rent, salary, repair, and maintenance, utility fee, among others to ensure it keeps running. However, many a time, situations like increased accrued receivables, i.e., not receiving payments from customers on time can put the business in jeopardy. If cash flow is not handled well, then a company could go out of business, overnight.
Merchant cash advances are primarily meant for businesses whose revenue come mostly from sales made through debit and credit cards. As such, they work best for retail stores and restaurants but can also be a practical cash flow solution for B2Bs, as well.
Merchant cash advances are technically not like loans. In fact, their format is totally different from that of bank loans which make them a much-opted financing solution for small businesses. Merchant cash advance providers give businesses an upfront amount of cash in exchange for the business’s future sales.
• You can pay a percentage of your future credit or debit card sales per month which would include the principal and the fee amount.
• You can pay a fixed sum every day or every week, which would include part of the principal and fee and would be fixed irrespective of the sales your business is making. This amount is deducted daily or weekly from your bank account. These withdrawals are commonly referred to as Automated Clearing House (ACH) withdrawals.
The latter is now the preferred merchant cash advance type for most businesses and is known as ACH merchant cash advances. It enables businesses which do not draw their revenue from debit and credit card sales, to also access this particular kind of funding, thereby making its client base larger than the traditional type of merchant cash advances. The ACH merchant cash advance makes repayment easy for businesses by deducting the principal and fee on a weekly or daily basis, instead of a monthly sum, until the amount is paid in full.
One of the primary differences between merchant cash advances and bank loans is the APR component. While for banks an APR (Annual Percentage Rate) determines that repayment amount, merchant cash advance providers use a factor rate
to ascertain the risk involved in making the cash advance. Factor rates typically range from 1.1 to 1.5, in which 1.1 signifies relatively low risk and 1.5 signifies relatively high risk. Higher the factor rate, higher will be the fee component in your repayment amount. This is how you calculate how much amount you will need to repay for a merchant cash advance of, say, $50,000 with a factor rate of 1.5.
Merchant cash advance: $50,000
Factor Rate: 1.5
Repayment amount: $ (50,000 x 1.5) = $ 75,000
Out of the total of repayment amount of $75,000, the fee component comprises $25,000.
The repayment period for merchant cash advances ranges from 3 months to 12 months. If you have opted for credit card sales-based repayment and your sales are high, then you will be able to repay the amount in a shorter period of time.
For example, if your merchant cash advance provider prefers that you pay 10 percent of your monthly debit or credit sales till you repay the entire $75,000, and your retail store averages $ 100,000 worth of sales each month, then you will be paying $10,000 each month, till you repay the entire amount of $75,000 in 7.5 months’ time. You could further break the $10,000 into $333 of daily payments (assuming a 30-day month).
However, businesses see ups and downs based on demands, socio-economic situations, etc., and maintaining the same level of sales might not be possible for most businesses. In case of sales lesser than $100,000, for example, we can consider, $80,000 as a monthly average the business will be paying $8000 per month or $267 on a daily basis, to ensure complete repayment in a little over 9 months.
In most cases, sales are not really an issue for small business when it comes to cash flow issues. It is mostly not being able to collect their receivables from customers on time and having to pay vendors at regular intervals. This interrupted cash inflow, followed by regular cash outflow is what spells cash flow problems for businesses and owners are left looking for quick financing options that will give their business the cash boost they need, right at that moment. The lengthy loan origination and underwriting processes at banks are not their top choice when times are dire, and the cash requirement is urgent. So, even though bank APRs are way lower than the fee component of merchant cash advances, business owners prefer to go for cash advances as it provides assured lump sum upon request.
Over the years merchant cash advances have become extremely popular given their quick nature and easy repayment options. Here are some reasons why make merchant cash advances so popular.
Merchant cash advances allow the business to run smoothly in the face of a sudden cash crunch by providing them with immediate cash support without long and tiring rounds of paperwork and verifications. Merchant cash advance providers look at the daily credit card receipts of the business to ascertain the risk profile and whether the business can repay the amount. It then applies a factor rate based on its analyses and transfers the amount to the business. Its quick nature has made this mode of cash financing popular among businesses.
Unlike traditional bank loans, you are not required to provide any kind of collateral to receive a merchant cash advance. This means that the merchant cash provider will not forfeit any business or personal asset in case of failure to pay due to a dip in sales. They do however ask for a personal guarantee through a written agreement which makes you personally liable to pay back the advance.
In case your sales are not going as well as you had imagined they would, then repayment in fixed percentage might hurt your business’s cash flow. In these cases, you can negotiate to reduce the percentage and increase the repayment term to make sure you can pack back completely and comfortably, without the business slipping into another cash crunch situation.
With the arrival of fintech and easy financing options like merchant cash advances and invoice factoring, businesses now have easier solutions to their cash crunch situations. Although the fee component might be on the higher side for these funding solutions, yet it is up to businesses to decide what they find more reliable, assured upfront cash advances for a higher fee or applying to a traditional bank loan at a lower APR, without the certainty of the application getting approved. The choice totally depends upon the requirements of the business filing for the advance.