Factoring vs. Merchant Cash Advance

Factoring, Finance
Using factoring services or getting a merchant cash advance both put money in your bank account quickly, but there are several things to consider when deciding which is the best option for you.

What is Factoring?

Factoring is a financial service where a factoring company purchases your open invoices. You usually receive payment for those invoices within 24 hours. You can choose which invoices to sell to the factor and you’ll receive an advance on each of them. Some factoring companies advance up to 97% of the total amount of the invoice.

Since the factor purchases these invoices, they collect the payment from your customer. The factor then deducts its fee and returns the remaining balance. Factoring fees are typically small, so you should receive about 97-99% of the original invoice amount once the factor gets paid by your customer. If your customer does not pay, the factor manages the collections, not you.

Factoring is not a loan. You are collecting money for services already rendered and the factor makes its money on the factoring fee, so there is no interest involved. Factoring is commonly used in the trucking and oilfield industries because companies must purchase materials, pay labor and cover operating costs in advance of collecting payments from their customers. Factoring is also used by new businesses that need capital to support their growth but lack the credit history to obtain a traditional loan.

What are Merchant Cash Advances?

A merchant cash advance is a financial service where an MCA provider offers a cash advance based on your future credit card sales. You pay back the advance plus interest in installments from an agreed-upon percentage of your daily credit card sales. Oftentimes, it’s between 10 – 20%. This means the daily dollar amount that is debited directly to the MCA provider will vary, depending on the total amount of your credit card receipts on a given day. Interest rates for MCAs are typically high so you may end up paying as much as 20 – 40% more than the amount advanced.

Merchant cash advances are most often used by companies that have a lot of credit card sales, such as retail stores and restaurants. It’s easier for a small business that may not have a great credit history to qualify for an MCA.

How Do Factoring and Merchant Cash Advances Compare?

Factoring provides access to cash that has already been earned, usually within 24 hours, so you don’t have to wait 30 – 60 days for customers to pay. A factor will only purchase invoices for your customers that have a decent credit rating. Once the factor purchases the invoice, your risk of customer nonpayment is eliminated. The factor gets paid through factoring fees collected from each invoice.

A merchant cash advance is funded from future credit card sales. Once your application is approved, you’ll receive payment typically within two days. With no collateral and no personal guarantee required, the risk to the lender is high. This means the interest rates and fees may be high. The MCA provider gets paid a daily percentage of your credit card sales through direct access to your merchant account, until the full amount plus interest is paid in full.