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Merchant Cash Advances Vs. Invoice Factoring
If a business is short on cash and needs it sooner than later, then it often goes for one of the two options: merchant cash advances or invoice factoring.
Merchant cash advances and invoice factoring are not loans but rather alternative forms of financing. They are different from traditional sources of funding which require following a stringent approval process. There are a lot of differences between merchant cash advances and invoice factoring.
Invoice factoring involves the selling of incoming invoices of the borrowing company to the factoring company. The factoring company safeguards the borrowing company against bad credit and collects receivables from the company’s customers.
Companies can then be in a position to know the amount they are going to get at the end of the period of factoring. Factoring companies deduct a factoring fee and interest charges. When new invoices are made, they are normally brought to the factor for funding.
The factoring company generally advances about 85% cash against the invoices. The factoring company will also retain a small percentage as payment of interest. Interest rates depend on existing sales and are lower than those of a merchant cash advance.
Invoice factoring is suitable for companies that have a high growth rate or are currently experiencing high growth rates.
Invoice factoring is also suitable for businesses which have been in operation for almost three years and have problems qualifying for traditional bank loans. Factoring usually provides capital in real time which enables a business to complete time-critical business decisions such as purchasing inventories or hiring additional employees.
Invoice factoring is not considered to be a credit line or a loan. It is the purchase of receivables by the factoring company. A business has the additional benefit of receivables, management, collection, and credit advice on new and existing customers and even guaranteed credit at times. This lets business owners create a healthy business environment.
Factoring companies usually fund distributors, staffing companies and service and manufacturing companies. Medical and even construction receivables are also factored although the factoring company will be more stringent towards them due to the nature of their businesses.
Merchant cash advances commonly referred to as MCAs. They are quick cash advances given to businesses and are repaid by deduction of credit sales from the company which applied for the MCA. The MCA lender’s risk is greater than that of invoice factoring, hence the interest rates for MCAs tend to be higher.
They are ideal for small businesses with steady credit card sales for a given period of time of about four to six months. The merchant cash advance company debits a business bank account on a daily basis to ensure repayment of the cash advance. MCAs are most effective when a business needs to purchase equipment or products to facilitate increases in sales.
It is wise to be aware of your current business situation and keep an eye on the short and long term effects of both merchant cash advances and invoice factoring. It is only advisable to consider them when you are in dire need of cash.