Running a successful business requires regular cash flow and working capital. Every business experiences periods when sales are down and money is tight. When this happens, you may look to outside sources of funding. A merchant cash advance is one of the various types of small business funding options.
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Cash Advance Loans: A Quick Fix, But at What Cost?
Need cash fast? A cash advance might seem like the answer, but it’s crucial to understand how they work and the potential drawbacks.
Personal Cash Advances: Borrowing Against Your Paycheck
Imagine this: you need money now, but your payday is still a week away. A personal cash advance lets you borrow against your future paycheck. Essentially, you’re selling your future income for cash today.
The catch? High fees. These loans often come with hefty charges, and if not managed carefully, can lead to a cycle of debt. While they can offer a lifeline in emergencies, it’s important to consider alternatives like credit cards or personal loans if possible.
Merchant Cash Advances: Fast Cash for Your Business
For businesses needing a quick injection of funds, a merchant cash advance (MCA) is another option. Unlike traditional loans, MCAs are based on your future credit card sales.
Here’s how it works:
- You receive a lump sum of cash.
- You repay the advance (plus fees) through a percentage of your daily credit card transactions.
MCAs can be a good fit for businesses with strong credit card sales, but they often come with higher costs than traditional loans.
The Bottom Line
Cash advances – both personal and merchant – can provide quick access to cash, but it’s crucial to weigh the costs and consider alternatives before taking the plunge.
Key Points to Remember:
- High fees: Cash advances typically have higher fees than traditional loans.
- Debt cycle: Personal cash advances, in particular, can lead to a cycle of debt if not used carefully.
Alternative options: Explore options like credit cards, personal loans, or other forms of business financing before opting for a cash advance.
How does a merchant cash advance work?
Merchant cash advance companies will most likely work with your business if you rely primarily on debit and credit card sales. This includes retail, service shops and the restaurant industries. However, these are two structures that would allow your company to get an advance if you don’t have high debit or credit sales:
- Traditional merchant cash advance: Your businesses would gain an upfront sum with a traditional merchant cash advance. To repay the loan, a set percentage of daily or weekly sales is debited back to the cash advance firm until the advance – plus fees – is repaid. This is also known as a “holdback.” The higher your company’s sales are, the faster the advance is repaid. However, do not encourage your customers to pay in cash to avoid a percentage of their sales going to repayment, as this is a breach of contract and could result in litigation.
- ACH merchant cash advance: With an ACH merchant cash advance, you would receive a sum upfront and then repay the advance through your company’s checking account. A fixed daily or weekly sum is transferred from your business checking account through an Automated Clearing House (ACH) withdrawal until the advance – plus fees – is repaid. Unlike a traditional merchant cash advance, the debited amount remains the same regardless of your company’s sales. These advances can be paid off more quickly than an advance that is debited against sales, unless your business runs out of available cash, in which case you may be unable to make your daily or weekly payment.
How much you will pay in fees depends on how much risk the merchant cash advance firm is taking. Generally, the factor rate will be 1.2 percent to 1.5 percent. If you take out a $40,000 advance with a 1.5 percent factor rate, your total payment will be $60,000 (your $40,000 advance with $20,000 in fees).
A merchant cash advance is considerably more costly than traditional financing. It can also create a debt cycle that would force you to take out a second advance to pay back the first – resulting in additional fees.
Alternatives to a merchant cash advance
If you need extra cash but are wary of a merchant cash advance, consider other financing solutions that provide working capital for your small business. There are a variety of small business loan types to choose from. Lines of credit, term loans and payment processor financing are just some of the options.
Business line of credit
A line of credit (LOC) is similar to a credit card. You can apply for and be approved for a set amount, which you can borrow against for the term of the LOC. You can never owe more than the upper limit of your line of credit, but you can repay the amount you owe and borrow again as many times as you need. You can open a line of credit for your company for any amount, often ranging from $2,000 to $500,000. Funding is generally approved in less than a week, and repayment terms are three to 12 months.
Fundbox is one lender that provides business lines of credit. Fundbox’s fast, transparent application; pricing; and approval processes can offer up to $150,000 over three to six months. Fundbox is known for its direct communication regarding how much you’ll pay per week for its services and will automatically withdraw these fees from your bank account. Learn more in our full review of Fundbox..
Short-term loan
A short-term loan is an unsecured business loan offered by a private lender rather than a bank. These loans have lower interest rates and more transparency than a merchant cash advance, though lenders will review your credit history. Short-term loans generally offer up to $500,000 in one-time financing, are approved in less than a week and have repayment terms of three months to three years.
Fora Financial is a top lender for short-term small business loans. With Fora, your repayment period will be at most 15 months, and you can obtain a loan of up to $500,000. You can set your payment schedule to fit whatever terms work for you, and you won’t have to put up any collateral. Plus, the approval process takes just 24 hours, with funding of the loan as quick as 72 hours. You can learn more in our comprehensive review of Fora Financial.
FYI
There are a variety of lending options for your company. The best small business loans have an easy application process, transparent pricing information and flexible repayment options.
Payment processor financing
If you use a credit card processing company like Square or PayPal, you may be eligible for financing these companies offer. You can apply for the loans, which are generally under $100,000, through your online account. They usually come with a factor rate of 1.1 percent to 1.16 percent – lower than a merchant cash advance.
