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Merchant Cash Advance: What Is It and How Does It Work?

merchant cash advance

Merchant cash advances are an alternative form of business finance that’s popular with small businesses that need funds but don’t have assets to provide as security. With a merchant cash advance, the lending is secured with future sales made through your card payment terminal. Repayments are automatically made, with a fixed percentage of your sales made through the card terminal. The repayment portion never enters the bank account of the borrowing business but goes directly to repay the lender. Since future payments act as security, there is no collateral required. This makes it a simple form of small business financing for companies that mainly get paid through credit cards, debit cards or EFTPOS.

How to get a merchant cash advance

If you have a card terminal in your business, there is a business that processes your transactions for you. When you get a merchant cash advance, the lender will work with the terminal provider to get a clear understanding of your finances. This includes your monthly sales and cash flow. If you have enough revenue through card payments and healthy cash flow, it’s likely you will be approved for a merchant cash advance, with a typical maximum amount of the advance being your average monthly sales.

Merchant cash advance case study

To better understand merchant cash advances, let’s look at a hypothetical case study of an ice cream shop that gets most of its sales during the warmer months of the year. Unfortunately, their freezer breaks down at the beginning of summer. The business does not have the cash on hand to buy a new freezer. It contacts a merchant cash advance provider and explains its urgent finance needs. The merchant cash advance lender contacts the card terminal provider to get the ice cream shop’s financial data, particularly monthly sales. It can see that the average card sales have been high enough to cover a loan to buy a new freezer.

The ice cream shop agrees to the terms of the loan, purchases the new freezer and is able to continue operating during the crucial summer months. As customers pay for ice cream with their debit and credit cards, a predetermined percentage of this revenue goes directly to the lender to pay off the loan, which includes interest. After several months of ice cream sales, the loan is paid off.

The advantages of a merchant cash advance

Fast access to funds

With a merchant cash advance, the borrower can get funds quickly. Lenders are able to act fast, contact the card payment processing company, get the information needed, make a decision and provide funds.  Since the decision is based on information that is easy to access, the borrower doesn’t need to spend time completing a lot of paperwork as with other types of small business loans.

Ease and flexibility

Payments are made automatically from card payments, so small business owners do not have to think about when payments are due.

Since the borrower is paying a percentage of revenue from card sales, it doesn’t create cash flow issues. When sales are high, more money is paid back to the lender. When sales are slow, the borrower automatically makes a smaller payment, so it won’t cause cash flow problems.

Disadvantages

It’s not for all businesses

This form of finance is most suitable for businesses that make a high volume of sales through credit cards, debit cards and EFTPOS. Companies that make predominantly cash sales or invoice their customers are not suited for this type of loan.

The interest rate can be high

Compared to other forms of finance, the interest can be high at around 20% per annum. If a company relies on merchant cash advances in the long term, the interest will add up.

Borrowing amounts are limited

The maximum merchant cash advance, based on average monthly revenue, may not be large enough to meet the borrowing needs of a business.  

Alternatives to a merchant cash advance

If a merchant cash advance is not suitable for your business, there are other financing options that are fast and easy to apply for. Unsecured fast business loans have been growing in popularity in recent years among small business owners. With Moula, for example, the application process is quick and simple. The online application takes around 10 minutes to complete and loan approval decisions are made within 24 hours.

Learn more about unsecured business loans from Moula. Also check out our business loan calculator for an estimate of principal and interest repayments for various loan amounts, terms and interest rates. 

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