What is a Merchant Cash Advance and How Does it Work?

A merchant cash advance (MCA) is a financing option that businesses leverage to access quick working capital. As opposed to a traditional loan, an MCA gives a lump sum upfront in exchange for a percentage of the business’s future credit and debit card sales. In essence, it is an advance on future card revenues.

Typically, repayment is made by deducting a fixed percentage of daily or weekly card sales until the advance, plus fees, is fully repaid. This means the repayment amount is dynamic and fluctuates based on sales volume. So higher sales lead to faster repayment, while slower sales extend the repayment period. In this article, let’s explore how merchant cash advances (MCAs) work in detail.

How Does a Merchant Cash Advance Work?

A merchant cash advance (MCA) provider gives a business a lump sum payment upfront. In return, the business agrees to repay the provider from a percentage of their future debit and credit card sales over a fixed period.

The loan provider takes a set percentage, typically 5-20%, of the business’s daily or weekly card transactions. This is automatically deducted from either the business’s bank account or their card payment processor account until the advance is fully repaid.

Unlike a loan, the repayment period and total amount repaid depend on the business’s sales volumes. In months with higher sales, more money is spent repaying the advance. In slower months, less is repaid.

Some providers may instead take fixed daily or weekly payments from the business’s bank account. This functions more like a traditional business loan with a set repayment timing. However, total repayment still varies based on the percentage taken from card transactions.

MCA Eligibility and Application Process

To qualify for a small business cash advance, basic eligibility requirements include:

•    Should have been operating for at least 12 months with stable monthly card sales
•    Maintain a minimum monthly card revenue (varies by provider)
•    Possess valid business registration and financial records

The application process is simple, and minimal documents are needed, such as recent bank statements, merchant loan processing statements, and possibly annual financial statements.

Many loan providers offer an instant pre-qualification process requiring only basic details of monthly card sales and time in business. This allows businesses to confirm potential approval amounts and terms prior to formally applying.

Once approved, funding can be available as fast as 24-48 hours, with funds sent directly to the business's bank account via electronic transfer.

How Are MCA Payments Structured?

In a merchant financing agreement, the financing amount, payment percentage, and contract duration all connect to determine the total repayment owed. Loan providers will assess the risk to tailor these terms appropriately.

1. Advance Amount

Also called the funded or financed amount, this is the lump sum payment provided upfront to the business. Smaller businesses may start with smaller amounts, while more established companies may secure larger MCAs.

2. Specified Percentage

The percentage, ranging from 5% to 20%, is the portion of daily future card sales to be paid until repayment is complete. A higher percentage equals faster repayment, but a higher overall cost. The percentage is determined based on risk; newer businesses often pay a higher rate.

3. Contract Duration

The duration typically ranges from 4 months to 18 months in most cases. Longer repayment periods mean you pay less each day, but you end up paying more overall because the payments last for a longer time.

Let us understand MCA funding with the help of an example:

●    Let's say a business receives a ₹50,000 MCA
●    The agreement specifies 15% of daily card sales 
●    The duration is 12 months

If the business processes ₹1,000 daily card transactions, ₹150 (15%) will go toward repaying the MCA. If the business’ best selling month brings in a sale amounting to ₹30,000, then that month, ₹4,500 will be paid as part of the MCA repayment.  

The business keeps paying 15% of its card sales each day until the total amount repaid equals the original advance plus the provider’s fee. Depending on sales, the full repayment usually takes between 4 and 12 months.

Benefits of Merchant Cash Advances

For many small businesses, MCAs present an attractive financing option when compared to traditional loans and other sources of working capital. Benefits include:

●    Speed: Quick access to funds with a fast, simple application process. No lengthy waiting for credit checks or loan approvals.
●    Flexibility: Repayment comes directly from a card sales percentage, so monthly budgets are unaffected. MCA payments automatically adjust with seasonal revenues.
●    Freedom: Providers do not restrict business operations or impose repayment penalties. The business maintains flexibility in how the capital is used. 
●    Quick Approval: Approval is based more on card processing history rather than personal credit scores. Newer businesses have increased options for securing funds.
●    Growth: The lump sum cash infusion allows businesses to take advantage of growth opportunities and manage expenses. Funds can be used for any business need.

MCA vs Business Loan

An MCA has some key differences from a traditional business loan provided by banks or non-banking financial companies (NBFCs). Here are some critical aspects:

Conclusion

While MCAs carry a higher cost of capital compared to traditional bank or NBFCs loans, they offer a viable financing option for many small firms needing quick working capital to grow their operations. For businesses with steady card volumes, merchant cash advances provide an accessible source of funding.

While typically more expensive than traditional loans, MCAs provide an important alternative for businesses needing quick working capital without the constraints of conventional lending.