Merchant cash advances (MCAs) may seem like an easy option for businesses needing quick cash flow. However, the actual cost of an MCA can be much higher than expected. To make informed decisions, it’s crucial to understand how MCAs work, their true costs, and their long-term impact on your business.
In this article, we’ll explore key factors that influence MCA costs, the associated fees, and important considerations before borrowing.
What Is a Merchant Cash Advance?
A merchant cash advance is a financing option where a business receives a lump sum of cash in exchange for a percentage of future sales. Unlike traditional loans with fixed interest rates, MCAs use a factor rate to calculate repayment amounts.
Businesses repay MCAs through automatic deductions from daily credit card sales or fixed daily payments until the total amount is repaid.
How Merchant Cash Advances Are Priced
The cost of an MCA depends on two main factors: the factor rate and associated fees. Instead of an annual percentage rate (APR), MCAs use a factor rate—typically between 1.1 and 1.5.
Example:
If a business borrows $100,000 at a factor rate of 1.3, it must repay $130,000 (100,000 x 1.3 = $130,000). This amount excludes additional fees.
Key Cost Influencers
Several factors determine the overall cost of a merchant cash advance:
Factor Rate
The factor rate serves as the cost multiplier for the borrowed amount.Repayment Timeframe
Shorter repayment periods lead to higher effective costs since the total repayment is condensed into fewer days.Sales Volatility
Although repayment amounts may fluctuate with sales, the overall repayment obligation remains constant.
Fees to Watch Out For
In addition to the factor rate, MCA providers may charge several fees that add to the total cost:
- Origination Fees: A one-time upfront fee, often 2–5% of the advance.
- Processing Fees: Charges related to transaction handling.
- Late Payment Fees: Costs incurred for missed payments.
- Early Repayment Penalties: Many MCAs require repayment of the full agreed amount, regardless of early payment.
Comparing MCAs to Traditional Loans
While MCAs offer easy access to funds, they are significantly more expensive than traditional loans. For instance, APRs for MCAs can range from 50% to over 200%, whereas small business loans generally have APRs of 4–25%.
Key Differences:
- Interest vs. Factor Rate: Traditional loans charge interest over time. MCAs charge a fixed factor rate that doesn’t decrease with early repayment.
- Repayment Structure: Traditional loans have fixed monthly payments, while MCA repayments fluctuate with daily sales.
How to Calculate the True Cost of an MCA
To understand the actual cost of an MCA, consider the effective APR. The factor rate provides only a basic idea of total repayment, but the repayment speed significantly impacts the true cost.
Example Calculation:
- Advance Amount: $50,000
- Factor Rate: 1.4
- Total Repayment: $70,000
- Term: 6 months (180 days)
Even though the factor rate is 1.4, the effective APR can range from 80% to 200%, depending on the repayment terms.
The Hidden Impact on Cash Flow
MCAs can strain your business’s cash flow, especially when sales fluctuate. Repayment obligations tied to daily sales can leave little cash for operational needs.
Common Challenges:
- Limited Operating Funds: Daily deductions can reduce cash for essential expenses.
- Risk of Multiple MCAs: Many businesses take out additional MCAs to cover shortfalls, leading to a debt cycle.
Alternatives to Merchant Cash Advances
Before choosing an MCA, consider these alternatives:
Small Business Loans
Traditional loans typically have lower APRs and predictable monthly payments.Business Lines of Credit
Lines of credit offer flexibility, allowing you to borrow only what you need.Invoice Financing
This option allows businesses to borrow against unpaid invoices.
Is a Merchant Cash Advance Right for You?
MCAs provide quick access to capital but come with high costs and daily repayment structures that can be burdensome. Before taking an MCA, calculate the true cost and explore alternative financing options.
By evaluating all your options and considering the long-term impact on your cash flow, you can make a more informed decision for your business’s financial health.
If you need help managing your Merchant Cash Advance debt, check out our article How to Effectively Restructure Merchant Cash Advance Debt or contact a representative at Daily Draft for personalized assistance.
