Is a Merchant Cash Advance Right for Your Business?

Having a lender on your side can be huge for early stage businesses with a high volume of relatively small transactions

Key Takeaways

1. What is a merchant cash advance?
2. What are the qualificationsfor obtaining a merchant cash advance?
3. How does the payback work?
4. The timing of your receipts is often more important than the volume of your receipts.

What is a merchant cash advance?

A merchant cash advance is a loan between a merchant and a funder that provides immediate cash to the merchant in exchange for a specified profit.

The word “merchant” dates back to the 13^th century to describe a class of enterprising people who sold goods and services to other businesses. That would be considered wholesale or business-to-business (B2B) in today’s terminology. Someone who sells goods and services to consumers is considered business-to-consumer (B2C) in today’s language. 

Relationship between merchants and funders

So, a merchant is anyone who sells goods to a business, to a consumer or to both. In most cases, a merchant has a steady volume of sales traffic and is established in an industry. Funders are any individuals, groups or sets of investors that are registered with the Federal Trade Commission and that meet the requirements to lend money to a merchant.

As merchants acquire the raw ingredients for their goods and convert them to useful products that can be sold to end users (i.e. customers), there is a cost associated with this conversion. This cost is realized in the sale of the product as it is purchased by customers.

However, there are many instances in which the timing of the conversion (from product to completed sale) does not meet the timing of the merchant’s expenses, or it does not permit the merchant to take advantage of golden opportunities in the industry it serves. Why? Because the timing of the merchant’s expenses to profits does not provide the merchant with enough cash on hand to make a large procurement in equipment, or to purchase the additional space need to take advantage of growth opportunities.

How merchant cash advances help

This is where a cash advance can help a merchant take advantage of market opportunities. In a merchant cash advance, the funder provides cash to the merchant today in exchange for re-payment (plus interest) at a set future date. The interest is the funder’s compensation for taking a risk on you, the merchant, and for letting you use the funder’s money to help grow your business. In this type of cash advance, the funder’s risk is determined by the quality of the merchant’s business—not the business owner’s personal payment history and credit score—which is how traditional banks typically establish a merchant’s credit worthiness.

How does a business qualify for an advance?

A company can be eligible for a merchant cash advance if it has been in business for six months and can show steady revenue above$10,000 as well as the ability to payitsexpenseswithouthaving “negatives”againstits bankaccount.Thebusiness must also demonstratethatithasa reasonable chance of continuingits present salesvolume going forward.

The size of a merchant cash advance is proportional to the amount of revenue produced. If you’re a merchant, a good rule of thumb is to expect an advance equivalent to 50 percent of your average monthly revenue. For instance, if a company has been in business for two years with average monthly revenue of $60,000 and it hasn’t incurred more than three negatives (insufficient fund notices) from its bank, then the merchant should be able to qualify for a $30,000 cash advance loan (see real world example below).

Payback

A “factor” is calculated for the advance and that’s what determines how much a merchant will have to pay the funder back at a set date in the future.

One big advantage of a merchant cash advance over a traditional bank loan is that the advance can be paid back over time–in small increments–by taking a percentage of the merchant’s receipts from credit card transactions.

Once a factor is determined for the loan, the payback is typically made over a six-month period and is taken from a percentage of the merchant’s daily credit card transactions.

Real world example: Suppose a merchant takes payments from three card holders and the three card holders average $2,000 per day each for a total of $6,000 per day. If the factor on the merchant’s $30,000 six-month advance is 1.2, then the merchant will be responsible for paying a total of $36,000 ($30,000 x 1.2) over the six-month term of the advance.

If the merchant operates six days per week, then the percentage is determined by dividing $36,000 by the number of operating days in over 6 months and then dividing by the number of card holders (i.e. three in this example).

Loan: $30,000
Factor: 1.2
Payback amount: $36,000
Operating days over six months: 155
Card holders: 3

$36,000/155/3= $77.92 per card per day or 4% per day per card.

Conclusion

An additional benefit of cash advance loans is that payments are proportional to the merchant’s sales. This way, the merchant’s required payments can float up and down with the merchant’s business cycle and end up being just a fraction of the merchant’s daily sales. Thus, if the business has a slow period, the owner doesn’t have to worry about a burdensome fixed payment because the advance will adjust to the actual sales of the business at any given time. If you or someone close to you is facing a business cash flow squeeze, please contact us right away and we’ll be happy to help.

Samuel Bethea is President of The Rosewood Groups, a small business development company, helping small business with cash flow and growth by assisting with financing and business planning.
Contact us at 307 215-8410 | www.therosewoodgroups.com