Understanding the True Cost of Business Cash Advance Loans and MCAs

When small business owners search for business cash advance loans, they are often looking for speed, flexibility, and access to capital that traditional business loans may not provide. However, what many merchants discover only after starting the application process is that these products are not actually loans at all. Business cash advances are not loans. They are popularly known as merchant cash advances (MCAs). It is a unique form of business financing where the cost is determined using a factor rate rather than an interest rate.

Unlike traditional business loans or small business loan products that disclose costs through an annual percentage rate (APR), merchant cash advances price funding differently. This difference is often difficult to understand for some business owners which is why they may face challenges in evaluating the true total cost upfront.

This article breaks down how factor rates work, how to calculate total repayment, and how business owners can evaluate business cash advance loans responsibly, before signing an agreement.

What is a Business Cash Advance Loan?

The term business cash advance loans is widely used among small business owners. However, it is actually a merchant cash advance (MCA) and not a loan. The Federal Trade Commission (FTC) and state regulators generally classify MCAs as a purchase of future receivables, not debt.

In a merchant cash advance, a funder gives a business a lump sum of funding upfront for their business needs. In return, the merchant agrees to sell a fixed portion of their business's future sales. The funder may collect this on a daily or weekly basis from the business bank account.

The reason MCAs are structured differently from traditional lending is because repayment is tied to revenue rather than a fixed repayment schedule. This structure places MCAs within the broader category of business financing, rather than traditional business loans or SBA loans.

How Merchant Cash Advances Work in Practice

A merchant cash advance (MCA) is a funding solution where a provider advances capital to a business based on their projected future sales. Providers evaluate a few factors to assess the quality of future sales of the business. Some of these factors are:

1. Monthly revenue
2. Bank statements
3. Credit card sales or debit card sales
4. Business bank account activity

For MCA, the underwriting emphasizes cash flow consistency rather than focusing heavily on personal credit or business credit score. This is why many business owners with bad credit or lower credit scores consider business cash advance no credit check options.

However, this does not mean that funders completely ignore the credit score. While most providers still review credit history, approval is typically not driven by credit score alone.

What is the Factor Rate?

The factor rate is the most important characteristic of business cash advances required to understand the cost of the cash advance.

A factor rate is a fixed multiplier commonly between 1.1 and 1.5, applied to the advance amount. To determine the total amount to be repaid by the merchant, this fixed factor rate is multiplied by the amount advanced. The result amount is the fixed amount the business must repay. This repayment amount does not change, even if the business repays early.

Unlike an interest rate, the factor rate does not account for time. This is why MCAs do not disclose APRs in the same way traditional business loans do unless required by specific state disclosure laws like those in California and New York.

Factor Rate vs Interest Rate: Why the Comparison Is Difficult?

Interest rates on traditional business loans are standardized under federal disclosure laws such as the Truth in Lending Act. However, business cash advance loans are not covered by the same framework because they are not actually loans.

This means that a lower factor rate does not always mean that the total remittance cost will also be low because the factor rate is a direct multiplier of the amount advanced. This is not the case with interest rates because a lower interest rates is always beneficial unless other hidden costs are added to the total cost.

In case of a merchant cash advance faster remittance may increase the effective cost, which may not be a case for other conventional loans.

Therefore, comparing MCAs directly to small business loan APRs can be misleading as both of them are very different in nature. However, small business owners must not worry about the transparency because several states, including California now require clearer cost disclosures for MCAs and other products as well.

How Remittance Works for Merchant Cash Advances

Unlike conventional loans, the remittance for MCA does not follow a fixed time period. It is typically automated through:

1. Daily sales remittances
2. Weekly withdrawals from a business bank account

Remittance adjusts with revenue to offer flexible delivery of funds during slower business days. However, the total purchase amount remains fixed. This type of a financing structure can be useful to manage short-term business needs. However, if used for larger capital, this structure may strain working capital, especially if sales fluctuate significantly.

Eligibility Criteria for Business Cash Advances

Eligibility requirements are generally less restrictive for business cash advance loans because they are not typical loans. The eligibility criteria may vary significantly across funders because MCAs are not covered by the same lending federal frameworks as other bank loans.

The general criteria includes evaluation of the following:

• Minimum monthly revenue
• Active business bank account
• Several months of bank statements
• Consistent daily sales

Because of this, MCAs are often used by startups and small business owners with limited to no credit, as they may not qualify for traditional business loans or SBA loans.

What is Business Cash Advance with No Credit Check?

The phrase business cash advance with no credit check is often used and advertised by merchant cash advance companies to attract applicants with poor or no credit. However, no credit check does not always mean credit is ignored entirely.

Most providers still review the business owner's:

1. Personal credit
2. Business credit history
3. Existing obligations

Funding decisions may primarily be driven by revenue and receivables but the credit score thresholds are not completely ignored. Business owners must carefully evaluate the purchase agreement if the funder actually entirely ignores credit scores because there may be hidden unfavorable terms for the merchant.

Merchant Cash Advance Companies vs Traditional Funding Providers

Merchant cash advance companies differ from traditional banks in several ways:

• Faster approval process
• Less emphasis on collateral
• Higher overall cost of capital

Traditional banks and SBA lenders offer lower-cost funding but require stronger credit history and longer underwriting timelines.

When Business Cash Advance Loans May Be Appropriate

MCAs may be a good option for:

1. Short term working capital needs
2. Emergency repairs or inventory purchases
3. Seasonal revenue gaps

They may not be an ideal financing solution for:

1. Long term business investments
2. Real estate purchases
3. Refinancing existing debt

Alternate Small Business Financing Options

Although business cash advance are not loans, they are a good financing solution for short term business needs. However, they can be pretty expensive and the financing structure can be confusing for some merchants.

Following are some alternate small business financing options that entrepreneurs can explore if MCA does not suit their business needs:

• SBA loans

• Business lines of credit

• Business Credit Cards

• Term loans
• Equipment financing
• Online small business loans
• Invoice factoring

Final Thoughts

Business cash advance loans are not actually loan products. Many business owners misinterpret them as loans. However, these are merchant cash advances where a funder offers a lump sum capital to a merchant who remits it as a portion of the daily or weekly business revenue. Since it is not a loan, the total remittance sum is calculated using a factor rate instead of an interest rate. This factor rate is an important metric to calculating the total cost of repayment.

Therefore, it is crucial for merchants to understand the factor rate and how it is used to calculate the total purchase price before getting into an MCA contract. When understood correctly, an MCA can serve as a flexible short-term financing option for small businesses facing cash flow challenges.

By understanding how merchant cash advances work, calculating total remittance, and comparing financing options, business owners can make informed decisions that align with long-term business needs rather than short-term urgency.