How To Calculate the True Cost of a Merchant Cash Advance (MCA)

What Is a Merchant Cash Advance?

A merchant cash advance (MCA) is a type of financing that provides funding in exchange for a percentage of a business's future sales. The lender approves you for funding, and you receive the cash up front. Then, you repay the capital you receive plus fees from your daily sales transactions.

An MCA is also called a credit card processing loan because it's typically used by businesses that accept debit or credit card payments.

When you apply, you negotiate the loan amount, the factor rate, and the holdback percentage with the merchant cash advance provider. The loan amount refers to the capital you want to borrow. The factor rate is the equivalent of the interest rate in an MCA agreement. Lastly, the holdback percentage refers to the portion of your daily credit card sales that will be used to pay off your advance.

Since payment depends on your sales, merchant cash advances don't have the same repayment terms as other types of business loans. The higher your credit card sales, the faster you'll repay the advance. On average, most merchant cash advance companies offer repayment periods ranging from three months to two years.

MCA Factor Rate vs. APR

State and federal laws regulate traditional loans (e.g., short-term loans and business lines of credit). But because merchant cash advances are considered a sale of your future credit card receipts, they're technically not a loan. This means they have limited regulation.

Merchant cash advance lenders aren't required to show you the APR on your agreement, and many providers take advantage of this. That's why it's important to be careful when working with merchant cash advance companies.

In practical terms, the factor rate tells you what you will pay back in total, while the APR estimate tells you how expensive that payback is on an annual basis. The faster you repay, the higher the effective APR tends to be.

MCAs offer small business owners an alternative financing option that doesn't require collateral or an excellent credit score. But the cost of borrowing against merchant cash advances can be high. Before taking out an MCA, take the time to understand the terms and how much it will cost you. We'll show you how to calculate your advance's APR below.

Total Repayment and a Worked Example

Merchant cash advance companies charge factor rates instead of the traditional interest rates you'd find with most financing products. Factor rates can be as low as 1.1 and as high as 1.5.

A borrower's rate depends on requirements that vary for each lender. Typical qualifications include your volume of sales transactions, time in business, monthly or annual revenue, and personal credit score.

Unfortunately, the higher the factor rate you receive, the higher the fees you'll pay. Pay attention to your contract terms, since vague repayment terms could mean hidden fees that will increase your cost of borrowing.

The repayment amount, also called the payback amount, is the total amount you'll pay through daily or weekly payments. Start with your total repayment amount to calculate your annual percentage rate (APR) on a merchant cash advance. You can use this formula:

Repayment Amount = Advance Amount x Factor Rate

For instance, if you're approved for an advance of $100,000 for a factor rate of 1.25, your total repayment amount will be $125,000.

Repayment Amount = $100,000 x 1.25 = $125,000

To figure out the percentage cost of the advance, divide the fees by the loan dollar amount. But first, calculate the fees by taking the difference between the repayment amount and the advance amount. This comes to $25,000 ($125,000 – $100,000).

Percentage Cost = $25,000/$100,000 = 0.25

Then, figure out the rate for a year by multiplying the percentage cost by 365 days. In this example, this comes to 91.25.

Annual Rate = 0.25 x 365 = 91.25

Finally, calculate the annualized interest rate by dividing the percentage cost by the number of days of the repayment period. If you agreed to repay the loan in six months, that would be 180 days. This gives you an APR of 50.69%.

APR = 91.25/180 = 0.5069 or 50.69%

If you take out a cash advance amount of $100,000 with a factor rate of 1.25 to be repaid in 180 days, you're paying an interest rate of 50.69%.

If you are comparing an MCA to a term loan or line of credit, a Clarify advisor can help you estimate total repayment, daily remittances, and the effective APR so you can choose the lowest-cost option for your timeline.

Speak to a Clarify advisor about MCA loans

Daily Remittances and Repayment Timeline

Most MCAs are repaid through daily remittances, meaning the provider pulls a set percentage of your card sales each day. Because sales fluctuate, your daily payment and payoff timeline can change week to week.

Your agreement should clearly show the holdback percentage and whether there is a minimum payment, a fixed daily amount, or additional fees that apply when sales drop.

What Is the True Cost of a Merchant Cash Advance?

Add all of the other fees to the APR to find the true cost of a merchant cash advance. The APR provides a consistent representation of the annual interest rate for borrowing. However, it doesn't reflect the total cost of borrowing because it excludes fees. So, you have to add additional charges back, such as origination fees and processing fees.

Ensure you understand the terms of your merchant cash advance agreement. Additional fees could increase borrowing costs. This is also one of the reasons you should be wary of merchant cash advance offers. Take time to get to know your provider. Check if they have an established website and if there are real people behind the company. Make sure they're legitimate.

Merchant Cash Advance vs. Term Loan vs. Line of Credit

Here is a quick comparison to help you decide what fits your cash flow and payoff timeline:

• Merchant cash advance. Best for speed and looser credit requirements, but often the highest total cost and the least transparent pricing. Repayment is usually via daily remittances tied to sales.

• Term loan. Best for planned investments with predictable monthly payments and a clearer APR.

• Line of credit. Best for flexible working capital and short-term needs, where you only borrow what you use.

When Are Merchant Cash Advances Typically Used?

A merchant cash advance is a type of small business financing that's easy to qualify for because it's accessible, quick, and easy. In fact, it's often used to cover working capital expenses, such as handling emergencies, paying rent on time, or covering employee wages and salaries. Most businesses that are successful in leveraging cash advances use them to fund high-profit opportunities. For example, you can cover the cost of an MCA if you use it to stock up on a quick-turnaround inventory.

Other ways to use an MCA to meet your current business needs or expand your operations include:

• Maintaining or renting equipment. You can use an MCA to expand your operating capacity by renting machinery to increase production. Business owners can also use the money to repair broken equipment.

• Hiring workers. You can use MCA funds to bring in extra help during peak seasons.

• Using it for emergencies. An MCA can help you out in a bind when unexpected things happen, such as downturns because of a pandemic. You can also use it to pay off your tax liabilities or other loans to avoid late fees.

The Benefits of Merchant Cash Advances

Even though the cost of borrowing merchant cash advances can be quite high, they still provide an alternative financing solution for business owners who may not be eligible for traditional small business loans.

Below are some benefits of a merchant cash advance:

Quick Approval

For business owners who don't have time to wait weeks for a loan, MCAs offer small business owners fast and easy access to cash. Most application processes are completed online, and MCA providers ask for minimal documentation.

Flexible Personal Credit Rating Requirements

Some merchant cash advance providers work with borrowers who have poor personal credit scores. Since the loan is paid back automatically through credit card transactions, lenders care more about the business's cash flow than credit history.

No Collateral

MCAs are classified under unsecured business financing. Borrowers don't have to provide collateral to secure their funding.

Repayment Based on Sales Transactions

With MCAs, daily payments are withdrawn automatically from your credit and debit card sales. You don't have to worry about coming up with a fixed payment amount; you pay your loan based on how well your business is doing.

Best Merchant Cash Advance Lender: Clarify Capital

Merchant cash advances can be costly, but sometimes they're the only available financing option. First, it's important to ensure you're dealing with a legitimate company. Don't give your financial documents to just any merchant cash advance company that offers you fast cash right away.

At Clarify Capital, we strive to offer financing solutions that keep costs low and opportunities high. We work with more than 75 lenders to find the best rate for you. You'll also be partnered with a dedicated Clarify advisor to help you throughout the process.

They'll help you choose the best loan option for you based on your business needs. Your advisor will ensure you understand the loan terms before you accept. It's our mission to help business owners secure financing to grow and expand their companies.

Apply now with Clarify Capital to get matched with the best merchant cash advance option for your business, with expert guidance every step of the way.

FAQ About Merchant Cash Advances

These FAQs answer the most common questions about MCA pricing, total repayment, and daily remittances so you can make an informed decision.