When business owners need working capital quickly, they may not have the luxury of applying for a traditional bank loan or pursuing other investors. In their hurry for funds, they can be tempted to borrow from a high-interest online lender, run up credit card debt or turn over access to their bank accounts to a merchant cash advance (MCA) provider. Those options will get infusion of cash quickly, but at what cost?
The explosion of online lending and merchant cash advance sites has proven very profitable for the site owners, but the phenomenon has brought business loss, rather than profit, for the majority of borrowers. What those borrowers may not realize is that they have a more affordable fast funding option: invoice factoring.
Also called accounts receivable factoring, invoice factoring is a proven source of prompt working capital that has helped businesses succeed and grow for centuries. Let’s look at funding your business through invoice factoring and see how it compares to merchant cash advance.
Factoring your invoices means that you “sell” those invoices to a factoring company that will immediately advance you a large portion of the value of those invoices. Factoring pays you for work you have completed, while merchant cash advance companies lend you a fixed amount based on unknown future sales.
Factoring companies help your cash flow by paying you what you are owed upfront so you don’t have to wait 30, 60, or even 90 days for your customers to pay you. Factoring your invoices empowers you to grow your company with a cash infusion for new equipment, additional staff, more inventory, expanded sales and marketing initiatives, or whatever else you need. Unlike unregulated MCA and online lending companies, factoring is a tried-and-true financing method with strict industry standards and ethical codes set by the International Factoring Association.
Here’s how it works:
Let’s say one of your customers owes you $10,000 for the work you completed to them. According to this customer’s payment terms, you won’t be paid before 45 days after they received your invoice.
- You decide to get paid now instead of waiting.
- You sell that invoice to a factoring company.
- Let’s say the factoring company advances you 95% — or $9,500. Advance percentages vary, based on your industry, your customers, and your factoring agreement.
- The factoring company collects from your customer.
- After your customer pays the factoring company in 45 days, you will receive the balance of the invoice value or $500, minus a small factoring fee.
- If the factoring fee is 2% of the $10,000 invoice, you could receive $9,800 for your $10,000 invoice.
Merchant Cash Advance
If you have had credit card sales for a certain number of months, you could be eligible to apply for a merchant cash advance. Merchant funding companies “advance funds” on your future credit card sales for a set lump sum and send you the cash. In concept, an MCA is a loan, based on projected sales in the future.
Here’s how it works:
Let’s say your credit card sales have averaged $10,000 per month.
- The MCA provider takes that average and issues you a lump sum, minus their fees, which can range from 10% to 25%.
- If their fee is 15%, you would receive an advance of $8,500 upfront.
- The MCA provider creates an agreement requiring you to repay that loan on a daily or weekly basis.
- The MCA company will automatically debit your bank account every day until you have repaid that $8,500, plus any additional fees.
- If your bank account does not have sufficient funds, the MCA company can debit your credit card to reach that $8,500. This will add more debt to your credit card balance at the interest rates that you pay the credit card company.
- In addition, the merchant funding company may also take their 15% fee out of each of your credit card sales.
If your credit card revenue drops to $5,000 one month, you still have to pay the same daily or weekly payments for the $8,500 cash advance. Because of the high interest rates that MCA lenders charge and the agreement terms, you can end up paying out more than 50% in fees over that $8,500 advance. You may have accrued $10,000 in sales, but after all is said and done, you could earn as little as $5,750 on that $10,000 of your revenue.
Facts about Factoring
Before you commit to any funding source, get the facts. Compare and choose the method that will work best for you. Both MCA companies and factoring companies can deliver quick payment and fast approvals, but the similarities stop there. One of the big differences between the two funding methods comes in when you look at the benefits you will receive.
Some people choose borrowing money from an MCA company because they think that’s the only way to get paid quickly.
Factoring Fact: Factoring companies also move fast to get you cash upfront on your invoices. Once you submit some basic paperwork, your application can be approved in as few as 24 hours and your first funding can be sent to you right away.
Both start-ups and established businesses can have less-than-perfect personal credit scores and few assets for collateral. If they can’t get approved for a loan or line of credit from a bank, some business owners turn to MCA companies with their less restrictive approval processes as a last source of working capital.
Factoring Fact: Factoring companies welcome new clients, regardless of their applicants’ credit history or collateral. Approval is easy and fast, even if you’ve been turned down by banks in the past. A factoring company looks at your customers’ creditworthiness when they are evaluating a business relationship with you, not your own assets or payment history.
MCA companies provide an advance, but offer no benefits to support your company in any way.
Factoring Fact: Top-tier factoring companies not only let you turn the funds sitting in your accounts receivable into cash in your pocket, but also provide benefits that save you money and time. Factoring companies can send out your invoices, handle your credit checks and collections, issue payments to your vendors, store your paperwork, and handle many other back-office tasks.
If you face cash flow challenges and need money promptly, merchant cash advance and invoice factoring are two options. You can be approved more quickly for these options than for a loan from a bank or other traditional lender and your acceptance is not dependent on your credit history or collateral. You can use the cash that you receive in any way you want; it comes with no restrictions.
However, these two options are very different in approach and results. Before you choose either merchant cash advance or invoice factoring, be sure to get the facts, understand your agreement, and know in advance the true costs for each of these business funding methods.
At Interstate Capital, one of North America’s leading factoring companies since 1993, you work with seasoned experts with a long track record of helping business owners receive their funding fast. By factoring their invoices with Interstate Capital, thousands of businesses have increased their cash flow and achieved new levels of success.
Contact Interstate Capital for a FREE factoring assessment today.