Are Merchant Cash Advances a Good Idea?

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Merchant cash advances are a popular alternative to a traditional business loan. Some benefits of merchant cash advances are that they do not require a long business or credit history to receive approval. The bad thing about MCAs is, as with all short-term financing, the payback rate tends to be a high percentage of the money received. 

You’ll have to evaluate your particular situation and the terms of the advance to determine if it is a good plan for you. However, generally, it is best to steer clear of merchant cash advances and any other short-term financing options if you can avoid it. But let’s face it, during a lawsuit where you’re recovering from injuries and missing days at work, you might not be able to avoid it if you need to cover the bills.

How Does a Merchant Cash Advance Work?

A merchant cash advance is not a loan. It is an advanced purchase of future cash flow. An alternative financing company will pay a business for a percentage of their incoming revenue over a set period at a discounted rate. If you need $10,000 now, then you might come to a deal with an alternative financing company for an advance of $10,000 over 120 days at a factor rate of 1.2. 

A factor rate determines how much you will pay for the advance. A factor rate of 1.2 means that you will pay $1.20 for every dollar you are advanced. So, if you receive $10,000, you will need to repay $12,000. With 120 days to repay the advance, you will end up paying the financing company $100 a day, making daily transfers to the company for the established 120 day period.

Applications for MCAs are quick and easy to complete, and funds are generally available the next business day.

When Is a Merchant Cash Advance Not a Bad Idea?

While you should typically avoid an MCA if possible, there are certain situations in which it is a good call for your business. If you need an MCA, you can follow this link for more information. Some examples of times when an MCA might be right for you are:

  • For an item that will immediately increase revenue
  • For quick repair of a key component of your business
  • For the expansion of your business

An Item That Will Immediately Increase Revenue

If there is an item that can immediately increase your daily revenue, but you don’t currently have the funds available to make the purchase, then a merchant cash advance could be a good option. 

For example, say you own a bar, and the only food you serve is peanuts and bags of chips, but you want to get into selling hot food, so you need to buy an industrial oven and stove top. Currently, your business barely breaks even, but you have run the numbers and determined that you could have a net revenue of over $1,000 more a week if you were to serve hot food. 

In this case, an MCA might be a good option for you, especially if you get a low factor rate of around 1.1 or 1.15. If you take an MCA of $5,000 over 50 days with a factor rate of 1.1, that would have you paying $110 a day for 50 days ($770 a week). So, if your calculations are correct, that would give you an immediate small increase in profits even while paying back the advance to go along with your large increase in long-term revenue.

Quick Repair of a Key Component of Your Business

If you have a key component of your business break down and don’t have the cash immediately available for repairs, this can be another time an MCA is a good option for your business. 

We can use the same example of owning a bar. Your oven breaks down, and you are no longer able to make the pizzas for which your bar has become famous. You just spent all of your excess capital renovating your bar and putting in a couple of pool tables, a foosball table, and a jukebox. If you don’t get your oven back in working order, your profits will drop dramatically. You take out an MCA, repair the unit, and pay back the small MCA in a couple of weeks.

The Expansion of Your Business

If you have an opportunity to expand your business, whether adding a second location or expanding your current space to accommodate more guests, but you have a small window within which to act, then a merchant cash advance could be just what you need.

Your bar is packed every night with people wanting the best people in town, your table games are a hit, and people are showing up at your door, but you have to turn them away because you are too crowded. The business next to yours closes, and you talk to the owner of the building about the possibility of leasing that space as well and tearing down a couple of walls to expand your capacity. 

The owner is open to the plan, but there are other interested parties, so you need to act quickly. Your calculations tell you that you need about $20,000 more than what you have on hand to expand your kitchen, table game options, and provide additional seating. 

It would take about a month to perform the necessary work to open the other half of the bar. But the business is currently making about $2,500 in net profit each week, and you believe the expansion will put that up to at least $3,500 a week after you open the additional space. You take an MCA of $25,000 to cover for any potential extra costs with a factor rate of 1.25 over a 100 day period. 

So, you are paying $312.50 a day (2187.50 a week), leaving you with slight profits during the month you are renovating. Then, if your calculations are right, those profits would increase to more than 50% of your profit levels before the expansion for the rest of the 100 days of the payment period.

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