Merchant cash advance and factoring transactions can benefit some businesses more than others. Some businesses even use factoring transactions as a way to outsource collection functions, or use cash advances as temporary financing when waiting for a traditional loan or infusion of cash from a less expensive source.
Both types of transactions can be costly if you use them for the wrong reasons. When considering using a cash advance or factoring service, you should take all costs into account and evaluate other sources of funding, also. Business cash advances especially can be very expensive, and repayment can have a big impact on your business operations. Consider the following before reaching an agreement with a provider.
Consider a cash advance if:
- You need funding for essential business functions, such as payroll or operational expenses, and do not qualify or have time to apply for a traditional loan
- Your business has the sales volume necessary to make repayments at a higher rate without adversely affecting business operations
- Your business cannot incur any additional credit obligations for the time being
Merchant advances work best for businesses with a predictable sales pattern and large amounts in credit card sales. Before considering an advance, you should seek other methods of funding that are less expensive, and address the reasons why the advance is needed in the first place. Advances are very expensive, and relying on them for operating capital can cost your business in the long run. Rates can run up to 80% in some cases. Most cash advance providers will charge between 25-35% of the total advance amount as a “fee” for providing the advance. Advances can be taken for smaller or larger amounts, and rates will vary for each type of transaction. Before taking an advance, make sure you have the resources available to make repayments as scheduled.
On the upside, advances require no collateral and are not a credit obligation. This makes them good options for businesses that are just starting out, especially if they are taken to capitalize on some immediate business opportunity. Though repayment of a cash advance is quick, you can usually negotiate with vendors for flexible or extended repayment terms. In this way, cash advances can be more convenient and a better fit for some businesses than a traditional bank loan or line of credit. Make sure that you read any advance agreement very thoroughly, as some vendors attach fees for modifications or “short” payments if your sales volume is unable to cover the safe retrieval percentage.
Factoring is a similar alternative financing arrangement that can be a helpful tool for many small businesses. Factoring involves the sale of invoices or receivable accounts to a factoring service provider, who then collects on the invoice. Factoring can be a solution for businesses that have large amounts in accounts receivable but need fast access to cash. It is less risky than a cash advance, because sales have already been made- in most cases; you’re just waiting on payment from customers that are billed in monthly increments.
Consider factoring if:
Your business can “factor” or sell only specific invoices or whole customer accounts. There is usually no requirement that all invoices or receivables for a specific customer be sold. Those customers whose invoices are assigned make payments on invoices directly to the factoring service.
- You want an alternative to traditional financing options
- Your business spends significant time or resources on collection functions
- Your customers have good credit or a stable financial history—factoring services evaluate the creditworthiness of your customers before approving invoices for purchase
Factoring is often used as a way to “outsource” collection functions. If your customers are difficult to deal with or are notoriously late in paying bills, factoring can be a very appealing option. Conversely, factoring can challenge customer relationships if the factoring company is unprofessional in its collection processes. The most common type of factoring requires that you notify customers of invoice assignment, which might indicate financial hardship or lack of reliability for future orders.
Consider the benefits and the drawbacks when evaluating a factoring or cash advance transaction. You should take into account the implications for your business, your customers, and your own financial liability when considering whether to use business factoring or cash advance services.