Merchant cash advances simply explained by Swoop

15th Oct 2020
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Merchant cash advances simply explained by Swoop

Does your client need a short-term cash injection? Do they take customer payments through a card machine or online processer?

If your client is looking for short-term financing to boost cash flow or generate working capital quickly and – crucially – they have a card machine or online payment processer, they might do well to look at a merchant cash advance (MCA).

What is a merchant cash advance?

Designed with retail businesses in mind, a merchant cash advance is a type of a business cash advance.

If your client is a sole trader, Limited Company or partnership and they take payment from customers via a card machine (PDQ) or online processer (ebay, Shopify, Tide etc) they can apply to specialist lenders who will advance them a cash sum based on their card sales. A merchant cash advance (sometimes known as a PDQ loan) is unsecured. Your client repays the money through a fixed percentage (usually about 10%) of their future customer sales. In other words, if their business takes regular payments through a card machine or online processer, they can use their recent takings as the basis for this kind of loan.

What’s good about an MCA is that if your client has a strong sales day, they pay back more that day. On a slower day, they pay back less.

Why use a merchant cash advance?

  1. It’s fast – your client can agree an MCA within 48 hours.
  1. Because they repay in line with their sales (versus the fixed monthly payments they’d pay if they took out a standard loan), the pressure is off during a low sales month because their payments come down too.
  1. Similarly, there is no fixed term – your client will make repayments to the lender only when they take payments from their customers. This means that, depending on the level of sales going through their card machine, they can pay off the MCA at their own pace.
  1. Your client doesn’t need to use any of their assets because this is not a secured business loan – it’s unsecured debt.
  1. Lenders may carry out credit checks, however credit rating is less important with this type of loan because the lender works directly with the company that processes transactions for your client and can therefore see how much money is flowing through their business.

How much can your client borrow?

They’ll typically be able to get finance equivalent to the amount of money their business receives via card transactions in an average month. So, the more their business processes, the more they’ll be able to borrow.

Can your client apply?

Lenders typically require your client’s business to process card payments amounting to a minimum average turnover of £2,500 a month. And they’ll need to have been in business for a minimum of three months. If your client’s business deals mainly in cash or another form of payment, an MCA isn’t for them.

How much does a merchant cash advance cost?

The total cost of a merchant cash advance (i.e. the amount your clients pay back to the lender) depends on the factor rate. This is a decimal figure (not a percentage) used to calculate how much the MCA will cost them. For example, if your client borrowed £10,000 at a factor rate of 1.2 for a 12-month term, they’d pay back a total of £12,000. The calculation is simply £10,000 x 1.2, which gives them £12,000.

Although this calculation looks like it’s based on a percentage rate of 0.2%, it’s not! With an MCA, all of the interest is charged to the principal when your client takes out the advance. This is the key difference between factor rates and interest rates. It’s why the advance isn’t priced using APR – APR is used for financing where interest accrues on the principal loan amount, which will get smaller and smaller as they make successive payments.

How do lenders determine your client’s factor rate and what do they require?

Lenders will vary the factor rate according to their assessment of your client’s business, the industry they’re in and the lender’s own risk assessment. Typical factor rates are between 1.1 and 1.5.

More specifically, a lender will want to see:

  • Credit card processing statements, typically from the past twelve months – these will show that your client has a solid history of substantial card sales.
  • Business bank statements, usually from the past three months – these will verify the financial health of your client’s business.

If your client is considering using a merchant cash advance to support their business, sign up for a free Swoop account and our team of experts can talk them through the process. We can help them find the right lender for their business needs. We can also provide insight into a range of other finance options and ways they could be saving money on their day-to-day business costs.