Should you consider a merchant cash advance or working capital loan to alleviate your cash flow problems? Or would that make things worse?
Sometimes even the savviest small business owners find themselves with money tied up and unable to cover operational expenses. Merchant cash advances and working capital loans are financing options that can tide small business owners over with liquid capital delivered directly to their bank accounts. If, like many business owners, you need more cash on hand, you may be considering one of these types of financing. When handled properly, these financing tools can keep a cash-hungry business running, but beware вЂ“ if misused, they may lead you into a vicious cycle of debt.
Editor’s note: Looking for a small business loan? Fill out the questionnaire below to have our vendor partners contact you about your needs.
Merchant cash advance vs. working capital loan
- Loan vs. non-loans: A merchant cash advance technically isn’t a loan. Instead, it’s a promise to funnel a certain amount of future credit card sales to the merchant in question. Working capital loans, on the other hand, mostly fall under the traditional definition of loans. When you take out a working capital loan, you receive a lump sum of money and then repay it, usually in monthly installments. While you get a lump sum of money with a merchant cash advance, it is repaid by taking a certain percentage of your credit card sales on a weekly, or sometimes, daily basis.В
APR: Merchant cash advances often cost more in the long run, as they are known for their exorbitant APRs. These can sometimes be as high as 200%. Finding working capital loans with reasonable APRs is much easier.
Risk: Merchant cash and capital loans, such as invoice factoring, payday loans Mentor differ in that the former is based on money your business hasnвЂ™t yet earned. Invoice factoring, though, is based on your accounts receivable, so itвЂ™s based on money youвЂ™ve earned but not yet received. As such, merchant cash advances are riskier. You can never be sure that youвЂ™ll bring in enough in credit card transactions to cover what youвЂ™ve borrowed.
Approval: Merchant cash advances are rarely tied to credit scores in the same ways as working capital loans. You might thus have an easier time obtaining a merchant cash advance if your borrowing history is poor.
- Use allowances: Although most merchant cash and capital loans donвЂ™t limit how you can use them, there are exceptions. An equipment loan, which is a type of working capital loan, can only be used to buy equipment. Merchant cash advances have no such limits.
What is a merchant cash advance?
A merchant cash advance is a form of financing that isn’t truly a loan. Instead, it is a financing option that provides immediate cash in exchange for a business’s future credit card sales receipts. In essence, when a business accepts a merchant cash advance, it sells the revenue of its future credit card sales for immediate payment.
Merchant cash advances are often used by seasonal businesses or those with cyclical sales to keep up cash flow during slow times of the year. Business owners can pay operating expenses and wages when sales are slow, then repay the merchant cash advance when their sales volume picks up and generate a profit. Since merchant cash advances are backed by projected sales, businesses with subpar credit scores also often rely on them for an injection of short-term working capital.
FYI: Besides operating expenses and wages, businesses use merchant cash advances for financing equipment, running paigns, hiring new employees, expanding inventory, buying materials or acquiring property.