Mr Harish Raghav runs a computer parts manufacturing unit in Hyderabad. He finds that his working capital is not sufficient to take bulk orders or carry out expansion plans. He thought of taking a business loan, but being a newcomer, his credit score is still a work in progress. Moreover, he does not own any valuable asset that can serve as collateral. For business owners like Raghav, Merchant Cash Advances (MCA) is a great alternative for getting a small business loan.
Everything You Need To Know
1. Definition:
Merchant cash advances are very different from conventional loans. In fact, it is more of an advance payment than a loan. The advance is made against the business future credit and debit card transactions. It has no fixed rate of interest or fixed tenure as the repayment is done from the sales amount. Let us say Raghav needs INR 50,000 to take a new order but he currently does not have that amount. He is quite sure that if he gets the order, he will make sales to the tune of INR 1 lakh. So, he opts for MCA with a factor rate of 1.2, which means he will have to pay back INR 60,000 (50,000 x 1.2 = 60,000) to the lender. But this amount is not paid as EMIs but via credit or debit card sales. Therefore, he agrees to a retrieval rate of 10 per cent i.e. if he makes a sale of INR 5,000 every day, INR 500 will go to his MCA lender that day. Similarly, an amount proportionate to his daily sales will continue to be transferred to the lender until the entire INR 60,000 is repaid.
2. Terminology
As you must have got an idea from the above example, the factor rate is not an interest rate. It ranges from 1.1 to 1.5 and decides the amount that the borrower will repay the lender. Lower the factor rate, better is the deal. Just multiply your loan amount by factor rate to figure out the total repayment value.
- Automated Clearing House:
As we know, MCA involves daily transaction of money with a portion of the revenue generated going to the lender. To make the process transparent and smooth, the clearing of these payments are done electronically. Known as Automated Clearing House, it facilitates the transfer of funds from owners’ business bank account.
Retrieval rate decides the amount the lender collects from the daily credit card sales of the borrower. The rate usually ranges between 5 to 20 per cent but can be higher depending on the agreement between the two parties.
3. Features :
Below are some of the advantages :
To reduce their risk element, financial institutes ask for collateral when sanctioning a loan; in absence of which the interest rate goes up. On the contrary, MCA does not demand any personal or business assets to be put on the line.
If the cash flow of the business is healthy, applicants get the whole amount within a week as advance providers make quick decisions.
- Simple Application Process:
Applying for MCA requires a simple process of applying online and uploading supporting documents, something that takes only a few minutes.
Unlike business loans based on a fixed interest rate, where one has to make a fixed payment every month, in MCA, the payment is proportional to the business’ revenue. It makes managing your expenses easier as in a lean phase; you have to pay a smaller amount.
An applicant can borrow a higher amount through MCA, something the traditional lenders would not be willing to especially if the borrower lacks decent credit score or adequate collateral.
- Credit Score not Important:
The eligibility of an applicant is not judged by his/her credit score when it comes to MCA as the advance is given on the consistency of the credit card sales, the experience in business, and the existing debts.
Last but not the least, when it comes to MCA you have the advantage of not having any penalty levied on you in event of early closure of the advance.
Few of the Disadvantages are :
- More Expensive than Business Loan:
Since the factor rate is a smaller number than the rate of interest, one may think that MCA is more economical than traditional loans. Well, not necessarily. In fact, you may end up paying more than your other options. Do your calculations before signing the agreement papers.
One must note that MCA repayment will not help you to build your credit score, as most lenders do not report them to any credit bureaus.
4. Is It Good For Your Business or Not?
There is no one right answer to that because funding requirements and eligibility criteria differ from one business owner to another. However, if you have urgent requirement of funds and your chances of business loan approval are low because of unsatisfactory credit history or absence of collateral, you can apply and use the amount via MCA to take care of needs. Positive cash flow will help you repay the amount quickly.
Conclusion
We are living in an era of digitalization with plenty of lending options around. Sometimes, a business owner like Harish Raghav has everything going for him but reasons like absence of collateral or low credit score stop him from spreading his wings. In such situations, MCA helps the smaller and upcoming businesses to soar. The advance can fuel the growth of the businesses until you build a sufficient reserve of cash or own collateral to apply for other types of loans.
