When it comes to securing capital to grow your business, you’ll face countless options that are worth considering. Two methods, merchant cash advances and factoring, can be some of the most convenient methods to quickly obtain the financing you need. But which is better? In this guide, we’ll compare factoring vs merchant cash advances to find out which is better suited for your business.
The remittance structure between invoice factoring and MCAs is one of the defining differences between these two types of financing.
MCAs are repaid by taking a percentage from your daily, weekly, or monthly credit and debit card sales. This means that your payments fluctuate with your sales volume, so months with greater sales will have larger payments while slower months will require lower payments.
With factoring, you aren’t forced to make remittance because the factoring company will be collecting the funds from your outstanding invoices. In exchange, you’ll pay a fee for the advance, known as a factoring fee.
Approval odds for merchant cash advances can oftentimes be higher if you have substantial, stable card sales.
The approval rates for invoice factoring will ultimately be determined by the credibility of your customers. If your business has customers with strong payment histories – you will likely have no problems getting approved. However, if your customers have a shaky history of making payments, you may not get approved and your factoring rate could be much higher.
Speed of funding is typically faster with a merchant cash advance. Because funders can easily browse through your business’s history of card sales – it oftentimes doesn’t take long to get approved.
With invoice factoring, your funder will need to sift through your outstanding invoices and judge their credibility and creditworthiness which can take much longer than other financing methods.
Qualifications and requirements for these types of financing are quite drastically different. For a merchant cash advance, the focus is predominantly on the business’s sales volume through credit card sales. The credit score requirements are typically more lenient than those for traditional loans, making MCAs accessible to businesses that might struggle to secure other forms of financing due to a lack of credit history.
Qualifications for invoice factoring hinge on the creditworthiness of your clients rather than your business. Factoring companies will assess the risk associated with advancing funds by evaluating the financial stability and payment history of the clients being invoiced. This means that even businesses with newer credit histories, or those not meeting the requirements of traditional financing options, can qualify for invoice factoring if they have reputable clients.
When it comes to the amount of financing you can secure, this will ultimately be determined by the amount of card sales or outstanding invoices you have.
With an MCA, you can often secure up to 90% of your monthly card sales as an advance amount. For instance, if your current revenue is $100,000 per month – most MCA funders will offer an advance of up to $90,000.
With factoring, your funder will typically advance 70% to 90% of the invoice value upfront, with the exact percentage depending on the agreement terms and the perceived risk associated with the invoiced clients.
Keep in mind that financing amounts will depend on a multitude of factors and they can vary significantly from funder to funder so be sure to do some research before committing to your financing.
If you need capital fast – MCAs are a better choice because of how quickly they can be funded. Because approval is heavily weighted based on your card sales – if your business has a strong history, your approval and disbursement of financing can be quite fast compared to other options. This is particularly beneficial if you face unexpected expenses or opportunities where financing is required. For example, if you have a unique opportunity to expand to a new location but need capital to increase your staffing – this would be a great option to secure the financing you need.
Another advantage is the flexibility in remittance obligation. Typically, your funder will require either daily, weekly, or monthly remittance as a percentage of your card sales, making it less rigid than traditional loan repayments that are fixed. This is great for businesses that experience significant seasonality as their payments are higher when sales are inflated and lower during the slower periods.
Finally, if your business lacks a strong credit score or collateral, opting for an MCA can be a simple way to secure financing.
The costs associated with MCAs are usually higher compared to other types of financing, particularly when translated into annual percentage rates. In some cases, the APR on MCAs can exceed 20% – so it’s important to weigh your options before committing to any type of financing. These higher rates can make it challenging to manage long-term cash flows and operational costs leading to problems down the road.
The structure of MCAs can also lead to a risk of entering a debt cycle, as the need for more financing may arise to repay the existing cash advance, especially if your business has seasonal income fluctuations.
Finally, the lump sum payment offered upfront is often subject to numerous fees, which can increase the cost of your financing further.
One of the main benefits of factoring is that it provides you with rapid access to cash, eliminating cash flow issues that often plague small businesses with a high volume of unpaid invoices.
When you use a factoring company, you sell your accounts receivable at a discount, giving you quick access to cash without waiting for your customers to pay. This process can be extremely beneficial if your business frequently encounters long payment cycles that can disrupt your business’s liquidity.
Additionally, factoring can offer a form of credit management as the factoring company usually takes over the collections process, freeing up your resources so you can focus on growing your business.
One of the primary disadvantages is the cost. Factoring fees can be higher than traditional financing rates, which can eat into your profit margins and cause future cash flow obstacles.
Factoring also depends on the creditworthiness of your customers, as factoring companies typically only purchase invoices from customers with decent credit ratings and credibility. If a customer fails to make their payments, the responsibility may still fall on you if your agreement with the factoring company is recourse rather than non recourse factoring.
Finally, this type of financing is also more rigid in terms of the amount of financing you can secure, as the amount is directly tied to the value of your outstanding invoices.
A merchant cash advance is best suited for businesses that need quick access to capital and have a high volume of card transactions. This type of financing is particularly beneficial for companies facing immediate cash flow needs or those with less-than-stellar credit histories because approval is largely based on sales volume rather than your credit rating. The flexible remittance structure of an MCA, which are tied to daily or weekly sales, make it a perfect choice for businesses with fluctuating revenue, allowing them to manage repayments more effectively in line with their income.
Invoice factoring is more suited if your business operates within industries that have long invoice payment cycles, such as manufacturing. It’s typically easier for startups to qualify for because the decision is based on the creditworthiness and credibility of your customers, not your business. The focus on client creditworthiness makes invoice factoring an attractive option for new businesses that may not yet have a strong credit history but work with reputable clients.
As a business owner, finding the right financing for your business can be challenging and cumbersome. Both merchant cash advances and invoice factoring can be suitable options for your business depending on your needs.
For businesses that need quick access to capital and have strong card sales, opting for a merchant cash advance is often a better choice.
For businesses that have a large volume of outstanding invoices that work with reputable customers – invoice factoring could be a strong choice.
If you’re unsure about which type of financing is best for your business, get in touch with Specialty Capital today and our experts can help guide you through the process to help you make the best decisions for your business.
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