How to Calculate Merchant Cash Advance: A Step-by-Step Guide
Juggling unexpected expenses or looking to fuel exciting new ventures for your small business? A Merchant Cash Advance (MCA) might seem like a perfect solution to get the cash you need quickly.
But before you get one, it's important to understand the costs involved. Knowing how much an MCA will really cost helps you make informed decisions and see if it’s the right financing option for your business.
In this guide, we’ll walk you through the step-by-step process of calculating merchant cash advances (MCAs). Understanding the actual cost of an MCA puts you in a better position to decide if it fits your budget and long-term financial goals.
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What is a Merchant Cash Advance?
A merchant cash advance (MCA) allows small businesses to get quick cash by borrowing against future revenue from credit card sales. Unlike traditional business loans, an MCA is not based on your credit score or collateral. Instead, it’s based on the sales your business is expected to make.
Here’s how it works:
The merchant cash advance lender gives you a lump sum of cash upfront.
You repay the advance by giving the provider a percentage of your daily credit card sales. The payments are automatically deducted from your sales.
The loan repayment fluctuates with your business's daily sales. On days you make more, you pay more; on slower days, you pay less.
Merchant cash advances offer fast access to cash, often within a few days. They’re attractive because there are no fixed monthly payments. However, higher fees and rates can make MCAs more expensive than traditional small business loans.
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Understanding the Costs of a Merchant Cash Advance
Before applying for an MCA, it’s crucial to understand how much it will truly cost your business. Unlike traditional loans with a clear annual percentage rate (APR), MCAs use a different system – factor rates.
Let’s break down these costs:
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Factor Rate vs. APR
An APR represents the yearly interest you’ll pay on a loan, expressed as a percentage. It factors in the base interest and any additional fees associated with the loan (origination fees, points, etc.). APR allows for easy comparison between different loan options by presenting the total borrowing cost as a standardized annual percentage.
On the other hand, lenders use a factor rate for MCAs instead of an APR. Factor rates are a single decimal number (usually between 1.1 and 1.5) that you multiply by the amount of cash you borrow to determine the total amount you owe.
The factor rate you’ll get can vary depending on the lender you’re working with. However, it’s often based on your time in business, revenue, personal credit score, and volume of sales transactions. The higher the factor rate, the higher the fees.
Key takeaway: Factor rates provide a straightforward way to calculate the total cost of an MCA, but they don't consider the time it takes to repay. Unlike APR, which reflects a yearly cost, a factor rate gives you a fixed repayment amount no matter how long repayment takes. This can be misleading if you take longer to repay.
Since repayments are based on your daily credit card sales, the repayment period can vary. If sales are slow, it takes longer to repay, making the MCA more expensive annually. If sales are fast, you repay quicker, reducing the annual cost. To get a clear picture of the true cost, estimate different repayment scenarios based on your sales forecasts. This helps you understand how the MCA will impact your business over time.
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Additional Merchant Cash Advance Fees
Aside from the factor rate, you also need to be aware of additional fees, such as application fees to cover the cost of processing your application, processing or administrative fees to cover administrative costs of setting up your MCA, or closing fees for closing the account before the agreed-upon term.
Some lenders might bundle additional fees into the factor rate, making it difficult to compare costs directly with other MCAs. Carefully reviewing the terms and conditions can help you identify hidden fees and ensure a more transparent cost comparison.
These fees may seem insignificant, but they can add up, especially for smaller MCAs. Don't be surprised by unexpected charges down the road. Always ask the MCA lender for a complete breakdown of all fees associated with your MCA.
How to Calculate the True Cost of a Merchant Cash Advance
To calculate the cost of a merchant cash advance, you can use the following formula:
Repayment Amount = Advance Amount x Factor Rate
The advance amount is the total sum of money you receive upfront from the MCA provider. As mentioned, the factor rate is the decimal figure that represents the cost of your MCA.
Let’s walk through a realistic example to understand how to calculate the MCA. For example, your advance rate is $10,000, and the factor rate is 1.3. Here’s a step-by-step calculation:
Determine the advance amount. In this case, it’s $10,000.
Identify the factor ate, which is 1.3.
Apply the formula above.
Repayment Amount = Advance Amount x Factor Rate
Repayment Amount = $10,000 × 1.3 = $13,000
So, in this example, if you receive an MCA of $10,000 with a factor rate of 1.3, you will repay $13,000 in total.
For those who prefer a more automated approach, various online calculators are available that can help estimate the cost of an MCA. A cash advance calculator typically requires you to input the advance amount and factor rate, and they will calculate the total repayment amount, percentage costs, and APR for you. Using a merchant cash advance calculator can save time and ensure accuracy in your calculations.
Why Should You Get a Merchant Cash Advance?
Here are five reasons why a merchant cash advance might be a good fit for your small business:
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Fast and Easy Funding
Unlike a traditional loan that usually involves lengthy applications and approvals, MCAs are known for their speed and simplicity. The application process is generally less complex, and you can often receive funding within a few days of approval. This can be a lifesaver if you need a quick cash injection to cover operational expenses.
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Fewer Eligibility Restrictions
Qualifying for bank loans can be tough, especially for young businesses or those with less-than-perfect credit. MCAs typically have looser eligibility requirements. Lenders often focus on your daily credit card sales volume to determine how much you can borrow and how you’ll repay it, rather than solely relying on your credit score.
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Flexible Repayments
Since MCA repayments are tied to your daily sales, you don’t have to worry about fixed monthly, daily, or weekly payments that could strain your cash flow during slower business periods. With an MCA, your repayments automatically adjust based on your sales volume for a smoother repayment experience.
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No Impact on Your Credit Score
Applying for a bank loan often involves a hard credit check, which can leave a temporary mark on your credit score. With MCAs, lenders typically use a soft credit check so it won’t impact your creditworthiness. This can be helpful if you’re concerned about maintaining a good credit score for future financing opportunities.
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Use the Funds for Almost Anything
Unlike some loans that restrict how you can use the funds, MCAs offer more flexibility. You can use the cash advance for various needs, like inventory, payroll, marketing and advertising, repairs, or unexpected expenses. This freedom lets you address your most pressing needs and invest in growth opportunities.
When To Consider a Merchant Cash Advance
A merchant cash advance is a smart choice for certain situations. Here are some examples wherein you might want to consider getting an MCA:
If you have short-term cash needs for unexpected expenses or to take advantage of new opportunities.
If you have limited credit history, an MCA can be easier to obtain because it’s based on future sales.
If your income fluctuates or you’re a seasonal business, an MCA's flexible payment structure can be beneficial.
However, MCAs are not suitable for all businesses because they can be more expensive due to higher fees and interest rates. If your business has inconsistent sales or lower profit margins, an MCA could become a financial burden.
It’s best to check out other financing options if an MCA doesn’t seem right for your business. Traditional bank loans, lines of credit, and SBA loans are alternatives that might better suit your needs.
Alternatives to Merchant Cash Advances
While merchant cash advances can be a tempting solution for quick funding, they might not always be the most cost-effective option. Here are some alternative financing options to consider for your small business, each with its own advantages:
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Business Line of Credit
A business line of credit works just like a credit card for your business. You get approved for a credit limit and can access funds as needed, only repaying interest on the amount you use. This offers flexibility, but be sure to maintain good credit utilization to avoid high interest charges.
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Business Term Loans
Term loans are a good option for predictable expenses or larger purchases. You receive a lump sum upfront and repay it over a fixed term with fixed monthly payments. The interest rate can be lower than MCAs, but qualifying typically requires a good credit history and business financials.
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Equipment Financing
Need new equipment but don’t have the funds upfront? Equipment financing allows you to spread out the cost of the equipment over time. Depending on your arrangement, you can own the equipment after completing the payments. This can be an excellent option for businesses relying heavily on specific equipment.
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Invoice Financing
Invoice financing can be a good option if your business generates a lot of sales on credit. You can exchange your outstanding invoices to a third-party company at a discount and receive immediate cash. This can improve your cash flow but can also come with fees.
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Grants
Government agencies and nonprofit organizations sometimes offer grants to small businesses, especially those in specific industries or locations. This can be a source of free capital, but grants are often competitive and may have restrictions on how you can use the funds.
Get a Merchant Cash Advance from SMB Compass
A merchant cash advance can be a valuable tool for qualified businesses. At SMB Compass, we understand that speed and ease of access are important factors for many small businesses.
That’s why we strive to offer competitive merchant cash advance rates with a fast and transparent approval process. Our MCAs come with clear terms, so you’ll know exactly what you’re getting into. Our fast approval process can get you the funds you need to address urgent needs and time-sensitive opportunities quickly.
We prioritize transparency in everything we do, so we also recognize that MCAs might not always be the perfect fit. Our team of experts will work with you to assess your business needs, explore all your financing options, and find the loan that best aligns with your business’s long-term financial health.
Transparency and getting you the right fit are our top priorities. Contact us today to discuss your financing needs! SMB Compass is here to help your business thrive.
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