Sometimes, you’re running a small business and things are going well, then, suddenly, you hit a cash flow issue. You’ve got orders to fulfill and employees to pay, but your customers haven’t paid you yet. Sound familiar?
Two options many small businesses turn to in such situations are merchant cash advances and factoring. Both are ways of getting cash in advance, but they are very different. Let’s dive into what merchant cash in advances and Florida factoring companies can do for you to cover cash flow gaps.
What Is a Merchant Cash Advance?
A merchant cash in advance (MCA) is a quick shortcut to getting cash for your business, and, of course, it comes at a cost. When you get an MCA, you’re essentially selling a portion of your future sales. Here’s how it works.
How Does a Merchant Advance Work?
You apply for an MCA with a lender, and if approved, you receive a lump sum of cash in advance. In return, you agree to pay back that sum with a percentage of your daily credit card sales. This means the lender takes a cut of your sales until the advance is repaid in full.
The Numbers Behind Merchant Advances
Let’s look at some stats. According to recent reports, businesses used nearly $18 in merchant cash advances in 2023 globally with the US leading the market. The six most popular application types were Retail & eCommerce, manufacturing, energy, IT, Travel, and Healthcare. This shows how popular the option has become for small business owners who need fast cash.
However, the costs can add up quickly, too. The repayment structure is based on your daily credit card sales, which means in high-sales months, the repayment will be faster. In slow months, it will take longer to pay off the advance.
Let’s say you receive a merchant cash advance of $10,000 with an effective annual percentage rate (APR) of 35%. This could translate into paying back around $13,500 over the course of the year.
So, be cautious because While an MCA might give you quick access to cash, the high APR and the daily payments could put a strain on your finances.
What is Factoring?
Factoring, on the other hand, is a completely different way of getting cash for your business. Instead of selling future sales, you sell your accounts receivable (invoices) to a third party, known as a factor, in exchange for immediate cash.
How Does Factoring Work?
Here’s how invoice advance works in practice step by step:
- You have an invoice from a customer who owes you money (say, $5,000).
- You sell that invoice to a factoring company.
- The factoring company gives you a large portion of the invoice amount upfront, usually around 70-90%.
- When your customer pays the invoice, the factoring company takes the remaining amount (minus a fee for their services).
The Numbers Behind Factoring
Let’s break down some numbers. The global factoring market is expected to reach over $5 trillion by 2025, with a major part coming from invoice advances alone.
Imagine you’ve got a $5,000 invoice from a customer, and the factoring company offers you 80% of that amount upfront. You’d get $4,000 immediately, and it will pay wages, services, and other costs.
When your customer pays the $5,000, the factoring company takes its cut (typically around 2-5% of the invoice), and you receive the rest. Does it sound better? In fact, it does: take a look at the final costs.
The Costs of Factoring
Invoice advance is often less expensive than a merchant cash in advance. Fees for invoice advance typically range from 1-5% per month, depending on how quickly the invoice is paid. The faster the customer pays, the less you pay in fees.
Factoring is ideal if you have a lot of outstanding invoices but no immediate cash flow. It’s often more affordable than an MCA, and you aren’t giving away a percentage of your future sales.
Some factoring companies even take the risk of covering your losses in case of a customer failure for a bigger upfront fee, so you’ll never have to repay the invoices. This makes invoice advance an effective tool for financial risk management.
The cost of the service is the primary advantage of factoring services over merchant cash advances, and there’s more.
Merchant Cash Advance vs Factoring: What’s the Difference?
So far, we’ve learned that both a cash advance and factoring are ways of getting fast money. But they work very differently. Feel free to use the cheat sheet below to refer to it anytime when you’re exploring opportunities to stabilize your cash flow.
Key Differences Between Factoring v Merchant Cash Advance
Which One is Better for Your Business?
If you’re deciding between a merchant cash advance and an invoice advance, it’s best to take some time to recognize your financial situation, needs, and how you operate. Both options are quick ways to access cash, but they come with very different terms, costs, and repayment structures.
Choosing the right option means understanding your cash flow, sales cycles, and how much flexibility you have in handling payments.
When to Choose a Merchant Advance
There are three situations, in which you might want to go for a merchant cash advance:
1. If Your Business Has Consistent Daily Credit Card Sales
A merchant cash advance is ideal for businesses that have a steady flow of credit card transactions. Maybe you have a retail store, restaurant, or any other business that relies on customers paying by card. The key advantage here is that repayment is tied to your daily sales, so during busy periods, you’ll pay off the advance faster, and during slower periods, it will take longer.
For example, if you run a coffee shop, you might get a merchant cash advance based on your average daily credit card receipts. If you have a particularly busy holiday season or a local event that increases your sales, your repayment will increase accordingly.
2. If You Don’t Mind Paying Back a Percentage of Future Sales
A major factor to consider with a merchant cash in advance is the repayment structure. You’re agreeing to repay a percentage of your daily sales, which means you’re giving up a part of your future income.
For some businesses, this is acceptable, especially if they have high monthly sales and can handle the extra cost. However, you need to weigh the effective annual percentage rate (APR), which can be as high as 40-50% and lead to a significant cost over time.
If you borrow $20,000 with an APR of 35%, you might end up paying back $27,000 over the course of the year. While the repayments are flexible and based on sales, the total cost might end up being quite high, especially if your business struggles with lower-than-expected sales.
If your business model can afford these costs without too much strain on your finances, then the MCA could be a good option. However, if your margins are thin, the high repayment costs might be an issue.
3. If You Need Fast Access to Cash But Can Handle the Higher Costs
One of the biggest selling points of merchant cash in advances is the speed. You can get access to cash in a few days, which is best for an emergency or urgent need for funds, like purchasing inventory or covering payroll.
Small businesses often struggle to get traditional loans from banks and get denied a loan due to lack of collateral or credit history. In this case, an MCA is an accessible alternative when time is of the essence. However, you’ll need to be ready for the higher cost, as the fees add up fast.
So, if you have a strong track record of daily credit card sales, an MCA could be the quickest, most accessible route for getting the funds you need. Just keep in mind that speed comes with a price.
When to Choose Factoring
Let’s also take a look at other three scenarios, where you’d rather benefit from factoring services:
1. If You Have Outstanding Invoices But Are Struggling with Cash Flow
Factoring is beneficial for businesses that have many outstanding invoices and cannot cover operational costs or take on new business. Manufacturing, construction, and B2B service providers see this as a common issue because their clients often pay invoices over extended periods of time, sometimes 30, 60, or 90 days.
By selling your invoices to a factoring company, you get immediate cash to keep the business running, while peacefully waiting for clients to pay.
For instance, in B2B, it’s typical for small consulting firms to complete a project for a client who is paying $10,000, but they’re taking 60 days to settle the bill. If you sell that invoice to a factoring company, you might get 80% of that amount upfront ($8,000). Then, once the customer pays the full invoice, the factoring company takes its fee (usually 2-5%), and you receive the remainder.
It works well when you need to bridge the gap between delivering a service and getting paid. At the same time, you won’t need to rely on credit card sales, which are quite unpredictable.
2. If You Don’t Mind Giving Up a Portion of Your Invoice Amount But Want a More Affordable Solution
Compared to a merchant cash in advance, factoring is a more affordable way to get cash fast. While you do lose some of the invoice amount, the fees tend to be lower than the steep APRs of MCAs. The typical factoring fee is around 1-5% per month, depending on how long it takes your customer to pay.
So, factoring is a better option for businesses that want to avoid the potentially crushing debt of a high-interest merchant cash advance. The main trade-off is that you give up a percentage of your invoice value, but in return, you get cash that doesn’t depend on the unpredictable nature of credit card sales.
If you factor in a $5,000 invoice and the fee is 3%, you’d receive $4,850 upfront, with the factoring company taking the $150 fee when the client pays. If the client pays on time, this could be a very affordable solution. In contrast, an MCA would take a much higher cut, and you could end up paying back more than the original amount you borrowed.
3. If You Don’t Want to Risk Your Future Sales, and Prefer a More Predictable Repayment Structure
Unlike a merchant cash advance, where you’re giving up a percentage of your daily credit card sales, factoring is more predictable because you know the exact amount you’ll pay once your invoices are settled. There’s no risk of paying back more than you owe because the amount you’re advancing comes from the specific invoices you’re factoring.
For businesses that are looking for a more predictable repayment structure, factoring is the safer option. The repayment depends on when your customer pays, not on your sales fluctuations, which means you can budget better.
Conclusion: Factoring vs Merchant Advance
Both merchant cash advances and factoring are very quick ways to access cash, but they come with very different terms. A merchant cash advance is a great option if you’re looking for quick cash and are willing to pay a premium for the convenience. On the other hand, factoring might be a better choice if you have outstanding invoices and want a lower-cost, more predictable way to get cash.
First, think about your specific financial situation, sales patterns, and how much flexibility you need. If you’re deciding between merchant cash advance vs factoring, remember to assess your cash flow needs and consider the costs before jumping in.
In the end, the goal is to keep your business thriving, whether you choose a merchant advance or invoice advance. The key is to make sure your choice fits your financial situation and contributes to your long-term financial health.
If you tend to consider factoring services and looking for a factoring company near me, feel free to reach out to Factoring Express. We’ll assess your situation and suggest the best financial solution for your case!
