The Merchant Cash Advance definition and How You Can Utilize it for Business Growth

merchant cash advance definition

Statistics have shown that some 80 percent of small businesses use some sort of financing to build their businesses, and even to embark on other developmental projects once the business has been established. Unfortunately, it is becoming increasingly difficult for small firms to have access to bank loans. In 2012 alone, according to one study, more than 61 percent of the loans requested from banks by small businesses were turned down and the dollar value of the loans declined by 55 percent. But searching for the cash advance definition, we learn that it is quite possible to obtain financing which are not loans for a business at all.

Simply put a cash advance is a commercial transaction in which a business franchise sells a portion of its future credit sales in exchange for some cash. It differs from a bank loan in many key aspects and for this reason, it is not considered as a loan in the usual sense of the word. It will be helpful to see just how much this difference is and in what ways an advance can prove to be the better option when compared with a loan from a commercial bank.

First things first: interest is not charged on merchant loans. One other thing that differentiates a cash advance from a loan is that there are no fixed terms regarding when the advance is to be completely repaid. Because of this, a merchant cash advance does not attract the usual penalty of late payment that is integral to bank loans. In contrast, while there is no reward for early repayment of a merchant cash advance, there are benefits that stem from early repayments of bank loans which can come in the form of discounts. Being that a merchant advance is not a loan per se; laws that govern loans do not apply to cash advance transactions. From the cash advance definition, it is clear that merchant loans transactions are mere commercial transactions and as such are governed by such laws as the uniform commercial code of each state.

In terms of documentation, that is documents that need to be provided in order to obtain financial assistance from providers, the requirement for a cash advance is quite minimal. Although the requirement will naturally vary from one merchant provider to another it would include evidence of ownership of the business facility, or at least one year lease for a rented facility. In addition to this, most companies will request a business license, a voided check, details of credit sales processed a couple of months before the application time, as well as bank statements. Of course, when compared to those required by traditional loan sources it is seen how minimal they are.

What makes one qualify for an advance?

In order to qualify for an advance, it is often a core requirement for the business to process at least $5000 in credit card sales each month. In the same vein, a business is usually entitled to one month of its card processing volume in advance, but some merchant providers can provide up to four times this amount if the business shows good prospects.

There is also the question of the kind of businesses that qualify for a merchant advance. For most merchant providers businesses that fulfill a large volume of their face to face business transactions using credit card cards are the ones best suited for a cash advance. This includes restaurants, clothing stores, liquor stores, spas, hair and nail salons, bookstores, medical offices, movie theatres, parking garages, coffee shops and so and so forth. In the same manner, there are some businesses which are generally excluded from obtaining a merchant cash advance. Gas stations, furniture stores, computer and vacuum repair, high ticket electronic stores are all usually excluded. In addition to the above list, most business firms having quite a large average transaction size that is less than 12 batches a month are exempt. More so, drop shipping, home-based businesses, and online merchants are generally not accepted for a cash advance.

How does merchant cash advance work?

Even though merchant cash advance definition tells us that it is a sale of the future credit of a firm in exchange for a lump sum of cash from a merchant cash provider, it doesn’t tell us much about how the whole process works. To begin, then, let us assume that a restaurant requests an advance of $50,000 from a provider. The merchant provider as a way of realizing profit multiplies this amount by a certain factor of say 1.5. Doing so means that the future credit sale of the business is purchased at a discounted price and is, therefore, not considered being an interest charge.

It is this factored amount that gives the total amount which the business is to pay back, and in this case, it would be $75000. Because the cash advance is to be repaid from credit card sales on mostly a daily basis, a percentage, or a fixed fee from the daily credit sales is usually paid to the merchant provider. Of course, whether is a fixed fee or a percentage is charged will depend entirely on what the provider is willing to offer. So, the retrieval amount will continue to be deducted until the advance has been repaid. The mechanism through payments are made to the merchant is an issue which deserves a close attention.

How do merchant loan vendors get their advance paid to them?

The most common method of settling the providers is that of split funding. In split funding, the processor usually remits to the provider based on what has been agreed and thereafter transfers the rest to the business. As for the escrow account method, the processor transfers the credit sales of the business into an escrow account while the merchant provider is empowered to deducts its own percentage and afterward transfer the remainder to the business. The least common method involves the provider debiting the business directly. Apart from split funding, the other two methods reduce the control of the business over the repayment process and usually results in delays of up to 48 hours before the business gets its funds.

Regarding the issue of a fixed fee or percentage payments, it has been the preferred choice for businesses to adopt a fixed percentage formula. Understanding cash advance definition makes one realize that this method makes for less strain on the cash flow of the business. Using a fixed percentage ensures the business pays less during hard times and more during hard times. This also means that the time taken to pay the loan will vary according to business conditions.  But when the fixed fee method is adopted a fixed amount is paid on a daily basis regardless of whether sales are good or bad. This means a somewhat predictable time frame for payment. However, adopting the fixed fee approach could strain cash flow especially when sales plummet.

Why you might want to opt for a cash advance

In the beginning of this piece, it was stated how it is that getting a loan is very difficult for small and medium-sized businesses. But since merchant cash advance definition show it is not a loan, it is much easier to obtain. The major thing that has endeared businesses to merchant providers is the ease and speed with which the advance can be obtained. There is hardly anything that compares to having a much-needed capital delivered in a matter of days. Apart from the ease, there is a high probability that a given application for cash will scale through. This comes about as result of the fact that merchant providers only look for credit scores from 500 and do not go seeking business plans or tax records from the merchants.

If there is one other thing that is most appealing about a merchant cash advance it is that there is no requirement of collateral of any kind as opposed to what obtains with bank loans. Being an unsecured loan, there is no true personal guarantee on the part of the merchant and as such only, the provider bears the risk. It is also possible with a cash advance to request a fresh advance even before the previous one has been repaid. What is mostly discouraged, if not disallowed, is for a merchant to seek a cash advance from more than one provider. In some instances, merchant providers have had to buy off the debt a merchant might owe another provider in order to prevent the unfavorable situation known as stacking.

Finally, some individuals tend to discredit merchant loans on the basis that they are much more expensive when compared with funding from traditional sources. Be that as it may, it is known that the unsecured nature of the loans makes for such costs. What is important, from cash advance definition, is that an interest-free fund is provided to small business in order to ensure their survival.

2 thoughts on “The Merchant Cash Advance definition and How You Can Utilize it for Business Growth

  1. Braden Bills says:

    It makes sense that getting a cash advance would be beneficial for a business. That way they can get extra money to afford something big! It’s nice that businesses can qualify for one pretty easily.

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