Discover How Does a Small Business Cash Advance Work?

In the dynamic world of small business, cash flow is king.

Understanding how to navigate the financial tools at your disposal can mean the difference between thriving and merely surviving.

“How Does a Small Business Cash Advance Work?” is your essential guide to one of the most agile financing options available today.

As CEO of Sunwise Capital, I’ve seen firsthand the impact that a well-timed cash advance can have on a small business’s ability to seize opportunities and overcome challenges.

This guide is designed to explain the cash advance process clearly and straightforwardly, explaining how these advances work, their benefits, and what you need to consider before applying.

Drawing from years of experience providing financial solutions to businesses, we aim to demystify the cash advance, transforming it from a complex concept into a practical financial tool in your arsenal.

Whether you’re facing unexpected expenses or looking to capitalize on a sudden market opportunity, let this guide illuminate the path to strategic, informed use of small business cash advances.

How Does a Small Business Cash Advance Work?

A small business cash advance, also known as a merchant cash advance (MCA), is a popular funding option for many small businesses with fluctuating or erratic revenue.

This financing option is fast and easy and provides fast cash when a traditional bank loan or funding options from a credit union are not available.

The MCA differs from a small business loan or other types of traditional loans in the payment structure and provides some flexibility with repayment.

MCA options have been around for many years but are now available to even more types of businesses. Learn more below to see if a small business cash advance suits you. It is important to understand the differences when comparing the MCA to a loan from a traditional lender.

In the past, an advance was used only for businesses that operated on credit card and debit card sales, like bars, restaurants, and retailers. It was the only option for businesses that had a high volume of credit card transactions. A business would exchange cash against future credit card sales.

These were mostly reserved for high risk business loans. The high risk is usually a reflection of bad credit or business credit and as an underwriting consideration by a lender.

Historically, companies required borrowers to switch their merchant card processing to receive a business loan. Today, this requirement rarely happens.

The MCA provider now gives you a sum of cash in return for a percentage of your credit sales without switching your merchant account. The other significant advantage is that there is less emphasis on your credit score and more focus on cash flow. Again, this is why some consider this financing a high-risk business loan.

Since companies don’t always make the same amount of sales each day, their income went up and down. A merchant cash advance was a way for them to acquire business capital to cover the times when sales were low.

In return, the lender would receive a percentage of your daily sales as payment. When the daily credit card sales were low, the daily payment would be small, and when the daily sales were higher, the payment would reflect those numbers.

A small business advance works similarly, but with a few differences.

For example, nearly any type of business can be eligible for an advance, not just the ones mentioned above. A merchant cash advance is not an actual unsecured business loan. Essentially, you receive one lump sum of money in exchange for the lender’s cut from future sales.

The total amount of business funding is repaid over an extended period, using daily or weekly payments plus fees. This is not a personal loan. The working capital the alternative lender provides helps the small business owner with cash that does not affect the balance sheet.

Why Choose a Merchant Cash Advance?

Many new or small businesses get turned down by banks when they apply for business financing and loans because they don’t have the credit or cash flow needed to qualify.

Even larger companies with significant revenue and operating histories get rejected by banks. Moreover, the speed and convenience outweigh the lengthy time and paperwork necessary to get a bank loan.

These newer or smaller companies have challenges getting approved and need loan options that work. They need opportunities for cash funding instead of business lines of credit. As we will discuss below, this type of financing has minimum qualifications and a one-page loan application. These MCAs work well, especially if you find yourself looking for bad credit business loans due to bad personal or business credit scores.

Companies that qualify for a bank loan are subject to strict repayment terms. This means that if your business is not bringing in enough revenue, the payment amounts could place added strain on your finances rather than lighten the load. The cash advance loan eliminates this additional financial stress.

The nice thing about MCAs as financing options is you won’t have to use your personal credit score or provide collateral to obtain the financial assistance you need.

Think of it as an alternative for those that can not get a secured business loan, or invoice financing (sometimes called invoice factoring). Plus, the payments will correlate with your success. Also, a small business advance is easy to qualify for, and funds can be acquired quickly.

However, there are several things to keep in mind when choosing these financing options. Remember that lower payments will extend the repayment time.

Also, with higher payments, the total will be paid off sooner, but the interest and fees will remain the same. If the terms meet the needs of your business and facilitate growth, then a merchant cash advance can be a great option as an alternative to a term loan.

What do You Need for a Cash Advance?

Traditionally, high-volume businesses with many daily credit card sales were the best candidates for this funding. Now, even more, traditional companies that are not retail establishments like bars and restaurants can qualify.

These are businesses that do not have high daily credit card volume but do have more than a few monthly deposits. One key factor is to have growing annual revenues. Almost every lender will tell you that growing revenues generally eliminate this financing option as startup business loans. Most will be less concerned about personal credit however will look for at least 6 months of operations.

How Much Does a Merchant Cash Advance Cost?

While cash advances provide immediate funding, they can be more expensive than an SBA or a traditional business term loan. Many years ago, you could find that these loan types had triple digits for an interest rate. The fees were excessive. Now getting quick cash doesn’t have to be extremely expensive.

The factoring rate can be competitive with credit card rates and the term loans an online lender provides. Many risk factors determine the loan amount and rates.

Factor rates can start as low as 1.15 and, depending on risk, exceed 1.4. To convert this rate, multiply your loan amount by the factor rate. For example, you borrow $50,000, and the factor rate is 1.18. Multiple the $50,000 X 1.18 which equals $59,000. You will pay an additional $9,000 on top of the original principal borrowed amount of $50,000.

The loan term is a function of what is commonly called the holdback. The holdback is the percentage of your daily sales used to pay back the cash advance. Holdback percentages range from mid-single digits to 30% of your daily transactions.

Going back to the example above, we’ll assume that you’re making $50,000 in sales a month. We’ll also assume a 22-day month for this example. That works out to about $2,272 a day in sales. You’ll then take your holdback rate; in this example, we’ll say it’s eleven percent.

Take $2,272 and multiply it by 11%, which equals $250 a day. Then divide $59,000 by $250, and you get 236 days to pay back the loan or almost eight months.

Remember that it may take more or less time, depending on your daily sales. Fortunately, you don’t need a business loan calculator to do this math; however, if you would rather use a calculator, go here.

Make more and pay more; make less and pay less.

How do Cash Advance Companies Work?

Let’s assume you are a restaurant and need restaurant equipment. For some reason, you cannot get equipment financing or a loan.

Securing a merchant cash advance is relatively routine with virtually all the alternative or online lenders. You will submit a one-page application with the last three months’ business bank statements.

Most lenders will do a detailed analysis of your cash flow and look at a wide range of variables, including credit, both business credit and personal, time in business, and type of industry, to name but a few. Usually, the decision is in 24-hours or less.

Once you receive the agreement and autograph it, there is a funding call to ensure you understand all of the terms, including rates, fees, etc.

Your business checking account is usually verified online. Once you have final approval, the funding can occur that day or the next business day.

How Do I Pay Off a Small Business Cash Advance?

The repayment terms may vary slightly, depending on the cash advance companies. Payment amounts and times can be determined in two ways.

Percent of Sales – With this type of cash advance, the lender would receive a percentage of your sales each business day. An estimate will be made based on current revenue to determine your repayment period, usually between 3 and 12 months.

If you make more sales than you had projected, the total amount gets repaid more quickly, and if you make fewer sales, it will take longer. Many times this option compares favorably to a short term loan.

Fixed Daily Withdrawals—This type of repayment uses an estimate of your total monthly sales to determine a fixed payment. You will pay daily or weekly, and the payment amount will be the same, regardless of sales.

Where to Get a Small Business Cash Advance

SunWise Capital provides fast and straightforward merchant cash advance financing options.

We love working with small to mid-sized business owners because we have been there ourselves. Learn more about the tools available to small businesses and let us know if we can answer any questions!