This article will focus on unraveling the cost of Merchant Cash Advances while also shedding light on Daily Percentage Rates and Factor Rates.

What exactly is an MCA, more commonly known as a Merchant Cash Advance?

An MCA, short for Merchant Cash Advance, is essentially a sum of money provided by unlicensed private investors who agree to buy a portion of a business's future revenues. This financial option is exclusively available to merchants, a term these investors use to refer to businesses. In an MCA, investors acquire a share of future receivables, meaning a percentage of the business's upcoming revenue. The underwriting process for an MCA typically involves an analysis of the business’s monthly bank deposits and accounts receivable aging summary report. Based on these factors, an offer is made to provide a lump sum in exchange for a significant slice of future revenue, usually at a discounted rate.

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The general strategy most MCA investors follow involves examining the business's bank statements from the last three months, calculating their total, and dividing by three to establish a monthly average gross bank deposit. The offer made to the business usually ranges from 100% to 150% of this average monthly deposit. The repayment terms are either daily or weekly, depending on the business's credit standing, and are done at a factor rate ranging from 1.10 to 1.50. This rate varies depending on the investor's terms and the credit and business profile of the merchant.

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For instance, if a business's average gross bank deposit is $100,000, an MCA funder might offer a net funding of $100,000. Assuming a factor rate of 1.50, the total amount to be repaid, also known as the purchased amount or RTR (Right to Receive), would be $100,000 multiplied by 1.50, equaling $150,000. In this case, the business's total repayment obligation, based on a factor rate of 1.50, would be $150,000.

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Typically, the repayment terms are set on a daily or weekly basis, as monthly repayments are considered highly illiquid for the funders. Daily payments facilitate the funders in issuing more MCAs since they receive funds on a regular basis. Continuing with the example, if the repayment term is 60 days, the daily payment would be $150,000 divided by 60, which equals $2,500. This amount would be paid every business day, excluding weekends and holidays, totaling 60 payments to settle the liability.

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The collection of payments is usually executed via daily ACH withdrawals from the business’s account. This process begins on the same day the funds are provided, and it's made possible because, during the contract signing, the business gives the funder a voided check and written authorization to perform such withdrawals.

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Merchant Cash Advances (MCAs) are becoming a popular financing option for small businesses aka merchants, offering quick funding with flexible repayment terms. Unlike traditional loans, MCAs are not based on interest rates but on factor rates, making the cost calculation quite distinct.

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MCAs provide funds as a lump sum to business owners, who then repay the advance from future sales, often on a daily basis. The effective rates for MCAs can vary significantly, ranging from 30% to over 350%, with repayment terms usually spanning from 3 to 36 months. The daily repayment amount is typically a fixed percentage of the business's daily credit card sales, allowing repayment amounts to fluctuate with sales volume. This means if the business does well, the loan is repaid faster, and if sales are slow, the repayment period extends, offering a flexible solution for businesses with variable or seasonal income.

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However, it's important to understand the actual cost of an MCA, which uses factor rates instead of traditional interest rates. A factor rate is expressed as a decimal or multiple, such as 1.2 or 1.5, indicating that you will repay 120% to 150% of the borrowed amount. Unlike interest rates that are recalculated over time, a factor rate is set at the beginning and does not change during the repayment period. For example, a $40,000 advance at a 1.20 factor rate means you'll repay a total of $48,000, making the cost of the advance $8,000.

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To understand the cost in terms familiar to most business owners, you can convert the factor rate to an Annualized Percentage Rate (APR). For instance, a $20,000 MCA at a 1.3 factor rate with a 180-day repayment period would have an actual cost of $6,000 (calculated as the total cost of $26,000 minus the original $20,000). To find the annualized interest rate, you would first calculate the percentage cost of the advance (0.3 in this case), and then annualize it. This specific example results in an annualized interest rate of 60.83%.

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While MCAs offer quick and relatively easy access to funds, the higher costs compared to traditional loans and the impact on cash flow due to daily repayments are important considerations for businesses.

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