Should You Use Cash Advances for Small Businesses Funding?

Business.com / Finances / Last Modified: February 22, 2017

Cash influxes are quite common when you are planning to setup a new business. Usually, owners look for credit lines or bank loans.

Cash influxes are quite common when you are planning to setup a new business.

Usually, owners look for credit lines or bank loans for funding their financial growth as these are some of the more popular resources in hand.

However, the concept of cash advances can also be adopted despite being a lesser known commodity in the world of finances.

In some places, "merchant cash advances" are pretty popular, especially for the startups and micro-businesses.

A detailed study by the Federal Reserve Bank suggests a greater inclination of entrepreneurs towards ‘lines of credit’ and loans, roughly 52 percent and 57 percent of the overall popularity.

Cash advances are also on their way up, capturing the market at a respectable seven percent. Out of these, at least 10 percent comprise of small business owners, featuring revenue tags lesser than $100,000.

In the end, it all pans down to the loan proceedings and the way funding is put to use.

According to the business stalwarts, the purpose should be the driving force behind a loan. Once the future has been visualized, it becomes easy for us to determine the approximate figure and the portion that goes into the job.

Related Article: What Are the Best Options for Financing a Franchise?

Mechanics of Cash Advances

The concept of cash advances isn’t synonymous to the usual loans, although both require timely repayment of the money. Cash advances are received against prospective future sales and the provider is capable of drawing out cash from the credit card transactions of the concerned business, in future. Payments, in this case, are usually made on a weekly or even daily basis.

Repayment of loans is made on the basis of a percentage called Holdback, based on the credit card transactions. The value for the same might range from five to 20 percent but usually remains the same once both parties mutually decide upon a figure.

However, the amount might certainly vary, depending upon the number of transactions. Another aspect to ponder upon is the factor rate, i.e. the existing cost of the cash advance. More of a preset figure, this can also be termed as the buy rate, expressed between 1.2 to 1.4.

Cost Comparing

Loans attract interests and penalties, with the figures being quite easy to calculate. The cash advances are pretty different and therefore it might be a bit difficult to compare the lingering costs. One major difference has to be the calculation of interest, with the cash advances charging them on the entire amount, at once.

For loans, the figure of interest changes as the principal is paid off on a monthly basis. Keeping up with the calculations, it can now be determined that cash advances usually attract heftier interests and therefore it is only advisable to use them for smaller financial needs.

Precisely speaking, cash advances are short-term loans and need to be used judiciously. Needs like procuring inventory, paying off workers etc. are best suited for making use of financial aids. Another factor has to be the time. This form of credit needs to be repaid within a span six months to two years. Unlike loans with timely benefits on foreclosure, the credit based funding will not be of any use when it comes to savings.

The net amount, including interest will be the same, irrespective of the timeline of payment. The good thing about this is the flexibility on offer. Unlike loans, owners need not be specific about the EMIs as advances allow us to pay more when in profit and less when things are going well.

Seasonal businesses are best funded by these advances as one can pay off depending upon the cash in hand. Overall, bigger firms with a yearly schedule are best served by business loans, more so for the transparency.

The cash advance should be the last option lest the business loan is absent or denied. Merchant cash advances do have their shares of highs but one must be cognizant of the interest rates and other pitfalls, quite common with these credit sources.

Related Article: Will Work for Funding: 7 Ways to Finance Your First Small Business

Differentiating Factors

  1. Funding Speed: This is a raging factor, loaded heavily in favor of cash advances. Online applications for the same are processed quickly and funds can be deposited into the account within a day. Bank loans, on the other hand, undergo intricate paperwork and might take weeks to materialize.
  2. Limits: Cash advances can cater up to $250,000 or slightly more, depending upon the user requirements. SBA-BACKED bank loans can be borrowed for something in the range of $5 million.
  3. Requirements: Ever heard of credit history and the bottlenecks. Well, no need to worry if you are looking for the quicker way out. The prerequisite would then be the history of transactions made through the credit cards. For the business loans, a credit score of around 700 is actually mandatory.
  4. Flexibility: Loans are generally restricted to the demographic as banks usually prefer to be in closer proximity with the owner. Credit card based financing are best suited for the entrepreneurs who need to travel across the globe for their clientele.
    For loans, collaterals are often required, in case the amount is on the bigger side. Personal guarantees would suffice, elsewhere.

Related Article:5 Surprisingly Cheap Forms of Small Business Financing

Bottom Line

As per the inferences, "Merchant Cash Advances" are often released faster and have a lot less paperwork associated. The credit history isn’t an issue with these funding techniques.

That said, business loans are more feasible in the long run. This is due to time-bound approach of the latter, allowing users to look into the details and understand the loopholes in a better way.

It all depends on the user preference and the urgency. However, for any kind of funding it is always advisable to take a bit of time and read between the lines, be it a slow paced bank loan or the speedy credit based financing.

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