For small businesses, cash flow is crucial. Often, business owners seek out funding sources that can help them meet their business obligations and provide a consistent influx of capital to drive growth.
One common method of financing is a Merchant Cash Advance (MCA). While not technically a loan, this method does provide an upfront sum of cash in exchange for a slice of future sales.
At a glance, MCA looks similar to invoice factoring. But is it? Here are four key differences between these finance methods:
1. MCAs can be more expensive than factoring.
Factoring fees are a percentage of the invoice, with a basic fee that applies to each factored invoice as established in your contract. MCA fees can be significantly higher than factoring fees, typically ranging between 20-50 percent of the amount borrowed.
Even if your sales meet forecast, you'll still end up paying back significantly more than your initial advance. While a 20-50 percent advance fee might be common, APRs can exceed 300 percent. Payment structures are also determined at the time of the advance, so you can't pay it off early to stop fees from accruing.
2. Invoice factoring maximizes cash flow.
Invoice factoring is designed to help small business owners maximize cash flow by advancing money against fulfilled invoices. When you factor an invoice, you get money immediately, which you can then use to invest in your company or make payroll.
MCAs provide you with a lump sum. If you use that money to pay off existing debts, you risk getting caught in a cycle of requiring another cash advance, multiplying the costs. Factoring offers more transparency, enabling you to know your cost and fees up front. Because it's the sale of your invoice, there is no interest to worry about.
3. Invoice factoring includes back office support.
When you agree to an MCA, all you receive is money. A crucial difference between MCAs and factoring is your factoring fee includes time and money-saving back office services that help your business grow.
4. MCA loans can affect existing loans.
MCA loans can affect equipment loans and factored payments. MCA loans often incorporate aggressive collection efforts, including automatically debiting daily payments from your bank account. As a result, factored payments may be debited before you have a chance to access them.
Though MCAs provide fast cash solutions when making down payments on equipment, access to fast cash can result in two loans with high monthly payments that are difficult to maintain. This can lead to needing another MCA loan. When MCA loans are stacked, cash flow spreads thin and becomes difficult to maintain.