Small businesses today have several opportunities available to them for obtaining capital. Each option has its pros and cons and a preferred situation for it’s usage. The best financing option for your small business depends on several considerations, such as the type of business, the industry your in, growth stage and stability of the company and the reasons why the business needs money. There is not a universal financing tool that will work for every business.
With this in mind, let’s take a closer look at two types of businesses that provide small businesses with funding options. First,factoring receivables invoice factoring companies and merchant cash advance companies. Both business financing choices have some commonalities and differences and both are used for similar and different purposes. This causes confusion with the two financial tools, so it’s important to get a firm grasp on when each of them is best utilized.
Invoice Factoring and Merchant Cash Advance: How Are They Different?
Despite their common uses, there are significant differences between factoring receivables and merchant cash advance. So let’s review their definitions: factoring receivables works when a small business sells its “current” unpaid accounts receivables or invoices to the factoring company. The company then purchases these invoices from the small business providing them with cash usually within a matter of days.
This way, the business doesn’t have to wait the 30-days or more to collect on the invoice so its working capital is maintained or strengthened. The factor takes its cut for expediting this payment process and then collects the invoice from the client during the normal payment window.
The definition of merchant cash advance is different. An MCA is where your business receives an advance, an agreed upon amount, that is based on the business’s “predicted” monthly credit card sales. The key word here is “predicted,” “future” or “projected” business sales. Your business then pays back this agreed upon amount plus interest over a set period of time. These payments are often deducted as a set percentage of daily credit card sales though terms may vary. Merchant cash advances can often be quite costly. This is particularly true if the “projected” monthly credit card sales differ from the real credit card sales.
Because account receivable financing is based on current sales rather than projected sales, they are more accurate, more equitable and generally less expensive. Calculating the true costs of merchant cash advances can be complicated, and businesses who use MCAs often don’t realize the actual price they end up paying. MCAs are often viewed as the most expensive loans out there.
Invoice Factoring and Merchant Cash Advance: How Are They Similar?
These two widely used financing methods are both categorized as alternative financing options. That means that neither of them requires traditional business loan vetting and verifications, such as minimum FICO scores, an established period of growth and profitability, or use of hard collateral such as assets, equipment, or properties.
Both account receivables financing (invoice factoring) and merchant cash advance are accessible to most small businesses even those that lack a record of profitability or a solid credit score. Therefore, applying for either of these alternative financing options is quick and easy and can generally be completed in about 30 minutes.
Both invoice factoring and merchant cash advance (MCA) offer fast cash options. Need cash this week, tomorrow, or even today? Factoring and MCA can help with same day or quick cash financing. This allows an increased flexibility that isn’t offered from more standard small business loans or private investment.
Both Options Can Be More Costly with MCAs Being More So
The downside to factoring receivables and merchant cash advance is cost. As is true in banking as it is in life, if you want something fast, you usually have to pay more for it. So both account receivable financing and merchant cash advance will generally cost you more than standard long-term loans.
Because the invoice factoring company or merchant cash advance provider is taking on a riskier agreement, they have to protect their own interests by charging higher rates. Many banks won’t issue loans to businesses with low FICO scores or businesses without proven record of profitability because of the risks involved.
That is, the banks take a big risk in not being paid back by issuing loans to unproven business entities. These risks are mainly involved with non-recourse factoring. Factoring and merchant cash advance companies are willing to take on the risk and offer this financing. However, it comes at a price in that businesses have to pay more for fast, unsecured capital.
Small Business Financing for B2B vs. B2C Situations
Generally speaking, account receivable financing is a better fit for business-to-business situations. So a manufacturing company that fabricates metals for a larger corporation is ideally suited for invoice factoring. In this situation, the larger corporation likely has a solid credit history and a record of profitability. This means there is a lower risk the corporation will not pay the invoice. Though it is riskier than a conventional bank loan, it is not considered a high risk situation because the client has been vetted.
Merchant cash advances on the other hand are generally suitable for business-to-consumer situations. In this way, retail stores, restaurants and other service providers make use of MCAs. Yet these are more risky because the credit verification is based on hundreds of thousands of credit card transactions from hundreds of thousands of customers. An individual is a riskier bet than a large corporation.
So now you know the basics of invoice factoring and merchant cash advance, how they are used and how they are similar and dissimilar from each other. Asking yourself if you are a B2B or B2C business can often tell you which financing option is right for you.