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Merchant Cash Advances | Why Businesses Seeking Finances Must Use Them Cautiously

Small and medium business owners love merchant cash advances because of their fast and hassle-free disbursement. However, this is one of the cases of a deal too good; which is why you should think twice before you use this form of financing.

MCAs are said to have triple-digit APRs or annual percentage rates that makes their total cost quite expensive.  These steep rates paired with their per-day settlement pattern are a recipe for cash-flow crisis.

The worst MCA plans lead merchants into an endless debt cycle where the debt is literally unmanageable and they have no option but to refinance into a next cash advance or file for bankruptcy. No wonder entrepreneurs are advised to use MCAs prudently.

That said, the rest of this write-up will discuss the MCAs in detail to help you make an informed business decision.

First Things First: Understanding MCAs

For a long time, MCAs have been for microbusinesses that rely on credit card sales. But today, the product is available for firms whose sales do not rely mainly on card sales. Cash advances are structured differently than loans. In essence, an MCA provider gives a business a lump sum of money in exchange for a portion of its forthcoming sales.

A business can settle the cash advance in two ways;

  • It can receive an advance amount of money in trade for a cut of its oncoming card sales, or
  • It can receive an advance amount that is paid back by deducting fixed per-day or per-week subtractions from its banking account, popularly referred to as ACH (Automated Clearing House) withdrawals.

Option (2) also knows as ACH merchant cash advances are a relatively new structure introduced to accommodate a business that does not depend on card revenue.

Paying Back a Merchant Cash Advance

MCA are paid back in form of per-day or per week remittances, plus fees, till the advance amount is settled. A provider deducts a percentage off your daily or weekly revenue.

The amount a business pays back depends on its ability to settle the cash advance. Typically, an MCA provider decides on a factoring rate, anything from 1.1 to 1.5 depending on your risk profile.

Here’s how to determine what a business pay’s back.

The Factor Rate X Advance amount = Payback Amount

But settlement for card-revenue dependent MCAs differ from that of ACH cash advances. With the former, repayments fluctuate depending daily card sales, and the speed of settlement can push APRs to triple-digits and determine how much you payback. And yet 80 percent of the time, according to Small Business Finance Association— an MCA lasts longer than the entrepreneur anticipated.

ACH cash advances, however, rely on an agreed-upon weekly or daily cut, and the amount remains the same whether sales are high or low.

Why MCAs Could Be Risky

So what could make MCA an expensive source of funding for your business needs?

  • APR may be triple-digits.
  • MCA contract terms and wording can lead to costly misunderstandings.
  • When sales are high, APR is high too.
  • You do not benefit if you pay back early.
  • No regulations control MCAs as a form of business financing because they don’t qualify as loans.
  • MCA providers are increasingly becoming concerned about credit status.
  • You risk entering an endless cycle of debt-cycle.

These risk factors explain why small business should always approach MCAs with caution.

To wrap up

If you must use a cash advance, make sure you get down to the mathematics of it and get familiar with all terms. A cautious approach can ensure you get business funding that won’t ruin your bottom line.