Merchant Cash Advances vs. Invoice Factoring

 In Alternative Financing

Merchant Cash Advances or Invoice Factoring: Which Is Better for Your Business?

MCAs and invoice factoring both offer fast access to business cash, but each option has very different pros and cons. This article will help you determine which one is best for your business.

The pandemic has shown that no business can be fully prepared for every possibility. When unexpected challenges arise, business owners need to get creative in order to solve their cash-flow problems quickly.

Banks are the traditional funding source for business loans, offering the most competitive interest rates and fees. But it can take a long time to qualify for and receive the funding, and  many businesses don’t qualify for these options because they haven’t been in business long enough, their business credit score isn’t strong enough, or their industry is considered high risk.

For these businesses, merchant cash advances (MCAs)and invoice factoring are popular funding sources. Both provide fast access to cash, don’t place restrictions on what you can use the cash for, and are available to businesses with a less-than-perfect credit score.

Some business owners may be more familiar with merchant cash advances than invoice factoring, but understanding the pros and cons for each funding type could save you a lot of money.

What is a merchant cash advance (MCA)?

A merchant cash advance is a type of business funding that the business receives in exchange for a percentage of its future sales, plus a high rate of interest and additional fees.

What are the pros and cons for MCAs?

Pros: Fast and easy. MCAs give a business access to cash in as little as one day, making it one of the fastest ways for a business to raise funds. And because MCA lenders base their lending decisions on a business’s past sales, there is minimal paperwork to fill out and a high rate of approval for businesses with strong sales.

Cons: Very expensive. MCAs are often considered a last resort because they are one of the most expensive type of funding. MCA lenders charge the highest rates of interest in additional to extra fees. As a point of comparison, credit cards charge 18-29% APR (annual percentage rate), while an MCA can result in an APR as high as 350%. Because of the high costs and an aggressive weekly or even daily repayment schedule, MCAs can quickly drain the business’s cash flow and create a vicious cycle of dependency.

It’s also important to understand that MCA fees are fixed, which means that you can’t reduce costs by repaying the advance faster. In fact, some MCAs even charge extra penalties for early repayment.

What type of business should choose an MCA?

Because MCA lenders need to see strong historical sales in order to advance cash against future sales, they are the best fit for restaurants and retail businesses that process a high volume of sales purchased on a credit or debit card.

Due to the high costs associated with MCAs, they should only be considered by businesses that have exhausted all other funding options, including invoice factoring, equipment loans, and even credit cards.

What is invoice factoring?

While MCAs are a type of advance based on past sales, invoice factoring (also known as “accounts receivable funding”) is a cash advance on a business’s accounts receivable.

A factoring company accelerates a business’s cash flow by advancing the cash as soon as the business invoices a customer for goods or services so that they don’t have to wait 30, 60, 90 days or even longer to receive the money.

What are the pros and cons for factoring?

Pros: Fast, flexible, and affordable. Like MCAs, invoice factoring is a fast way to access cash, even when the business lacks the track record or credit score that traditional lenders require. It can take as little as 4-6 business days for a factoring company to approve a business for funding and provide the cash for up to 90% or even more of the value of the business’s outstanding invoices.

Contracts tend to be more flexible than those for MCAs, so you can choose how many months you want to factor your invoices and whether to factor all of them or just a portion.

Most importantly, the rates for invoice factoring are significantly lower than MCAs—as low as 1% for 30 days. In addition, those rates cover a number of services that can save your business money, including invoice management, collections support, and credit checks on customers to ensure they pay in full and on time.

Cons: Up-front paperwork. Factoring companies only make their investment back if their clients’ invoices are paid, so they need to collect more information up front than MCAs. However, the process is still much less time-consuming and intrusive than a typical bank loan.

To apply for invoice factoring, businesses only need to provide articles of incorporation for the business, aging reports on accounts receivable, and two years of financial statements or tax returns.

What type of business should choose invoice factoring?

This type of financing is best for businesses that are unable to qualify for a bank loan, including startups and businesses experiencing financial setbacks. Invoice factoring may also appeal to businesses that want to avoid the time and effort involved in applying for a bank loan.

Invoice factoring is particularly valuable for businesses with high growth that offer payment terms of 30/60/90 days or more.

Invoice factoring is also a good fit for businesses that require a significant cash outlay in order to secure the resources required to deliver their products and services. Examples include staffing, transportation, distribution, government contracting, and manufacturing among many others.

Make the best choice for your business

Many business owners are faced with making tough choices in today’s economic climate, and when your business needs cash fast, it can be tempting to make a quick decision. But by understanding the pros and cons for each funding type, you can make choices that support your success—now and in the future.

To sum it all up: MCAs and invoice factoring both provide fast access to cash, but the high cost of MCAs makes them a last resort for businesses in search of working capital.  Invoice factoring is a more affordable and sustainable way to increase cash flow, so before you commit to an MCA, see whether factoring can give you the cash you need to keep your business growing.

Find out whether your business qualifies for invoice factoring: complete your application now.

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