Merchant cash advances (MCAs) offer a unique form of financing for businesses that accept credit or debit cards. When sales drop and businesses need a boost in working capital, an MCA can provide a quick solution. However, it’s important to understand the ins and outs of MCAs before considering them as an option.
What is an MCA?
A merchant cash advance is a type of funding where businesses pledge a portion of their future credit or debit card sales in exchange for a cash advance. Unlike traditional loans, MCAs do not require a strong credit history, making them accessible to businesses with low credit scores. Additionally, MCA are flexible in their eligibility requirements, allowing businesses with lower credit to qualify.
How do merchant cash advances work?
With a merchant cash advance, the cash is deposited directly into the business’s account. The advance is repaid through a combination of the borrowed amount, a factor rate, and other costs. Instead of charging interest, MCAs charge a factor rate, which is a predetermined percentage of the loan amount. For example, a $100,000 advance with a 1.4 factor rate would cost a total of $140,000.
Repayment terms for MCAs can vary, with some lenders requiring daily payments while others accept monthly payments. The repayment amount is determined by the business’s sales, making it a more flexible option compared to traditional loans. It’s worth noting that MCAs do not report payment history to credit bureaus, meaning they do not contribute to building business credit.
Calculate the Cost of Debt
How to calculate cost of debt? Calculating the cost of debt is an important step in evaluating the true cost and affordability of financing options, including merchant cash advances. The cost of debt refers to the interest expense that a business incurs in order to borrow funds. To calculate the cost of debt, you need to consider two key factors: the interest rate and the repayment period.
To calculate the cost of debt, follow these steps:
- Determine the interest rate associated with the debt, which is typically represented by the factor rate for merchant cash advances.
- Convert the factor rate into an annual interest rate by multiplying it by 365 (assuming daily repayment) or 12 (assuming monthly repayment).
- Consider the repayment period and calculate the number of days or months it will take to fully repay the debt.
- Multiply the interest rate by the repayment period to determine the total interest expense over that period.
- Take into account any additional fees or costs associated with the financing option, such as origination fees or application fees.
- Add the total interest expense and additional fees to get the overall cost of debt.
- Compare the total cost of debt to the amount of funds borrowed to evaluate the affordability of the financing option.
By following these steps, you can calculate the cost of debt and make an informed decision for your business.
Pros and cons of MCAs
Merchant cash advances come with both advantages and disadvantages. On the positive side, MCAs offer high approval rates, with some lenders accepting businesses with credit scores as low as 500. The funding process is also fast, with many MCAs being provided by online lenders who can fund within 24–48 hours. Additionally, MCAs do not require collateral, reducing the risk for businesses.
However, there are some drawbacks to consider. The repayment plan for MCAs can be demanding, with weekly or even daily payments required until the advance is fully paid off. The costs associated with MCAs, such as the factor rate, can result in high-interest rates, sometimes reaching 50-100%. Furthermore, MCAs do not contribute to building business credit, which can limit future financing options.
Merchant cash advance alternatives
While MCAs can be a quick solution for businesses, there are alternative financing options to consider. Term loans, for example, provide upfront funding that is repaid on a regular schedule, regardless of sales. Business lines of credit offer flexibility in borrowing capacity, with payment terms set but credit limits increasing as the loan is repaid. Business credit cards can be a suitable option for businesses that require smaller amounts of funding or do not qualify for traditional loans.
In conclusion, merchant cash advances can provide a quick injection of cash for businesses with credit or debit card sales. However, they come with high costs and aggressive repayment terms. Exploring alternative financing options may present more affordable solutions for businesses in need of funding.