businessFinanceProcess Improvementsmall-businessPros and Cons of Cash Advances

January 23, 2023by nicoleevansmcda0

According to data gathered by the U.S. Bureau of Labor Statistics, 20% of small businesses fail in the first year and close down in less than five. While some of these entrepreneurs fail because they failed to fill a need, had a poor business plan, or chose the wrong location, many small firms fail because they lack funding.

The problem is intricate. Self-funding is a popular strategy used by entrepreneurs to launch their small enterprises, but it is dangerous. Many of them use their emergency funds or retirement accounts to access the money they require, only to end up paying high fees and penalties. Another choice is small company loans, although it can be challenging to secure loans for companies with bad credit. Fortunately, there is still a choice—merchant cash advances.

What is a Cash Advance for a Small Business?

A small business financing alternative is a merchant cash advance, or MCA. An MCA provides a small business with a quick infusion of funds, comparable to a business loan, but that’s where the similarities end. Instead of making a monthly payment to a lender to repay the loan, merchant cash advances are repaid in one of two ways:

  • by the MCA provider taking a percentage of any card-based sales (credit or debit)
  • through fixed monthly payments directly debited from the business bank account

How Does a Cash Advance Work?

Unlike loans, MCAs do not carry interest rates. Instead, they use a factor rate that is determined by the specifics of the firm. Typically, the factor rate ranges from 1.1 to 1.5, though some are significantly higher. Some variables include:

  • Industry
  • Years in business
  • Current financials
  • Volume of documented transactions
  • Credit score of business owner

Example MCA

Consider a small business that needs additional funding to purchase enough inventory for the holiday season. The retailer requests a $30,000 MCA with a factor rate of 1.4 and a repayment requirement of 10% of monthly sales.

  • This means that the retailer will pay $42,000 over the course of the cash advance ($30,000 x 1.4).
  • If their monthly credit card sales are $20,000, they will pay $2,000 per month ($20,000 x 10%) or $67 per day ($2,000/30 days in a month) for 11 months.
  • If their monthly credit card sales are $40,000, they will pay $4,000 per month ($40,000 x 10%) or $133 per day ($4,000/30 days in a month) for 4.5 months.

However, take in mind that the final computation can include other costs. The precise expenses will vary depending on the lender and the business.

What are the Downsides of Cash Advances?

Getting a merchant cash advance can be costly. The merchant will spend an additional $12,000 to receive $30,000 in the aforementioned scenario, and they will have less than a year to pay it all back. Obtaining an MCA may be challenging for companies that don’t have a long history, work in challenging industries, or struggle to cover costs.

In this situation, it can be worthwhile to speak with an expert to learn about all the possibilities.

What are the Benefits of a Cash Advance?

Due to their high cost, merchant cash advances usually only help a business out when it needs to pay a temporary expense. However, they do work. The restrictions are flexible, and the business receives the money relatively quickly. Additionally, since MCA repayment is dependent on sales, the company doesn’t run the danger of having to make a sizable payment while sales are weak.

Additional advantages of a cash advance include:

  • No collateral required: No collateral is required to qualify for an MCA, which means that businesses that do not have the assets to offer as collateral can still access capital.
  • Flexible repayment: As mentioned, repayment is based on sales, so businesses only have to make payments when they are doing well. This makes merchant cash advances a good option for seasonal businesses or irregular sales.
  • Fast funding: One of the biggest advantages of an MCA is that the funding process is very quick. In many cases, businesses can get the money they need in as little as a few days.
  • Bad credit is okay: Because merchant cash advances are not loans, businesses that have bad credit (or no credit history at all) can still qualify.
  • Receive Lump Sum:  Businesses receive the full amount of the advance upfront, which can be helpful when a lump sum is needed to cover an unexpected expense.

Using a Cash Advance for Your Small Business

There are dangers and drawbacks associated with acquiring a cash advance for your small business, but they may be outweighed by the advantages of getting a quick influx of funds when you need it. Before deciding whether a cash advance is the greatest fit for your needs or whether small business loans would be a better option, do your research or contact MCDA CCG, Inc today with any questions!

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