Business cash advance transactions carry much higher fees than traditional bank loans. Usually, the “provider fee” is anywhere from 30 to 35 percent of the advance total. Businesses that present higher levels of risk, those that request a large advance, or those that do not have an established financial history, will usually end up paying much more.
The costs of a cash advance transaction can be expressed as follows:
Paying back a merchant advance is usually a quick process. The advance amount plus the provider fee is automatically withdrawn from your merchant account as a series of daily automatic payments, like this:
- Advance Amount: $10,000
- Provider Rate: 30%
- Repayment Amount: $13,000 ($10,000 + Provider Fee)
In the above case, the advance would be repaid in less than two months. The total cost of the advance is the “fee,” plus the opportunity costs associated with losing $250 of daily payment.
- Daily Credit Card Sales: $1,000
- Daily Retrieval Rate: 25%
- Daily Payment: $250
Business factoring costs depend largely on your customers. If the accounts you “sell” are collected on, costs are far less. In a factoring transaction, providers purchase an invoice at a cost anywhere from 20% to 90% of its value, depending on the risk level of the customer. The provider gives you an advance upfront in exchange for the rights to collect on the invoice. Once the invoice is paid, a provider releases the remainder, less their own fee:
The provider would still collect $10,000 from the customer as payment on the invoice, and then remit the remaining $2,500, less a fee. Fees for factoring are lower than those for cash advances. A typical fee in the above transaction would probably be somewhere around 5%, depending on the creditworthiness of the customer. Thus, the second payment would be for $2,000 ($2,500 less 5% of $10,000).
- Invoice Amount: $10,000
- Provider Discount Rate: 25%
- Advance Amount: $7,500 (10K less 25% of $10K)
Both cash advance and factoring can be expensive, depending on your circumstances. Factoring transactions tend to be more strategic, because they do not rely on the market to the extent that cash advances do. In factoring, the sale has been made, in many cases the goods have been delivered. The customer will be in default and can be sent to collections if they don’t pay. Cash advances are more uncertain, because they rely on the possibility of future sales for repayment.