Factoring vs. Merchant Cash Advance: Why Factoring Wins

As Warren Buffett once said, “Price is what you pay. Value is what you get.” When it comes to improving cash flow, factoring offers unmatched value compared to merchant cash advances, and it typically comes at a lower price. On this page, we’ll walk you through how each business funding solution works and do a quick factoring vs merchant cash advance comparison, so it’s easy to see which is the best solution for your needs.

How Factoring Works

Factoring is a financial transaction where a business sells its accounts receivable (invoices) to a third party, known as a factor, at a discount. This process provides the business with immediate cash flow, which can be used to cover operating expenses, invest in growth, or manage other financial obligations.

Overview of the Factoring Process

Each factoring company operates uniquely, though most follow a process similar to the one outlined below.

• Invoice Generation: A business delivers goods or services to its customers and issues invoices with payment terms, typically ranging from 30 to 90 days.
• Selling Invoices: Instead of waiting for customers to pay, the business sells these invoices to a factoring company. The factor typically advances a significant portion of the invoice value upfront, often around 60-95 percent.
• Receiving Payment: The factor then collects payment directly from the business’s customers when the invoices are due.
• Final Payment: Once the customers pay, the factor sends the remaining balance to the business, minus a factoring fee, which usually ranges from one to five percent of the invoice value.

Benefits of Factoring

There are several key invoice factoring benefits that make it an attractive option for businesses.

Improved Cash Flow

Factoring provides immediate cash, allowing businesses to cover operating expenses, pay employees, and invest in growth without waiting for customers to pay their invoices. This is particularly useful for businesses with long payment cycles.

No Debt Incurred

Unlike loans, factoring doesn’t add debt to the business’s balance sheet. It simply accelerates the receipt of cash that is already owed to the business, making it one of the more sustainable cash flow solutions for businesses.

Easier Qualification

It’s easy to qualify for factoring. Approval is generally based on the creditworthiness of the business’s customers, not the business itself. This means even businesses with less-than-perfect credit or limited operating history can qualify.

Flexible Funding

Factoring is often more flexible than traditional financing. Businesses can choose which invoices to factor, allowing them to manage their cash flow needs more precisely.

Focus on Core Business

By outsourcing the collection of invoices to a factoring company, businesses can save time and resources, allowing them to focus on their core operations and growth strategies.

Mitigates Credit Risk

Factoring companies often conduct credit checks on a business’s customers, providing valuable insights and helping to mitigate the risk of non-payment.

Scalable Solution

As a business grows and generates more invoices, the amount of financing available through factoring grows as well. This makes it a scalable solution that can adapt to the changing needs of the business.

How Merchant Cash Advances Work

A Merchant Cash Advance (MCA) is a financing option where a business receives a lump sum of cash upfront in exchange for a percentage of its future sales. This method is particularly suited for businesses with regular credit card sales needing quick access to capital.

Overview of the MCA Process

Each MCA provider follows its own process, though advances typically follow the structure outlined below.

• Funding Agreement: A business enters into an agreement with an MCA provider to receive a lump sum of money. The amount advanced is usually based on the business’s average monthly credit card sales.
• Repayment Terms: Repayment is made through a percentage of the business’s daily credit card sales, known as the “holdback.” This percentage typically ranges from ten to 20 percent. Repayments continue until the total amount advanced, plus a fee (the factor rate), is repaid.
• Factor Rate: The fee for the advance is represented by a factor rate, usually ranging from 1.1 to 1.5. For example, if a business takes an advance of $10,000 with a factor rate of 1.3, they will repay $13,000 over time.

Benefits of MCAs

There are several factors that make MCAs appealing to business owners on the surface.

Speed of Funding

MCAs can provide funds very quickly, often within a few days. This is especially attractive for businesses that need immediate cash to address urgent needs, such as repairing equipment, purchasing inventory, or managing unexpected expenses.

Ease of Qualification

Qualifying for an MCA is generally easier than for traditional loans. MCA providers focus on the business’s credit card sales rather than its credit history or collateral. This makes MCAs accessible to businesses with poor credit or those that haven’t been operating for a long time.

No Collateral Required

MCAs are unsecured advances, meaning businesses don’t need to put up any assets as collateral. This reduces the risk for the business owner in case of default.

Flexible Repayment

Repayment is based on a percentage of daily credit card sales, making it inherently flexible. If sales are low, the repayment amount is lower, which can ease the strain on cash flow compared to fixed loan payments.

Predictable Overall Costs

The cost of an MCA is usually fixed and defined upfront through the factor rate. This can provide a clear understanding of the total repayment amount, even if it is higher than other financing options.

Factoring vs. Merchant Cash Advance: Why Choose Factoring

Despite the positives, there are many merchant cash advance disadvantages and reasons why factoring is often the better decision for businesses.

Lower Costs

Factoring typically involves lower fees compared to MCAs. The factoring fee usually ranges from one to five percent of the invoice value, whereas MCAs can have factor rates from 1.1 to 1.5, translating to much higher overall costs. This makes factoring a more cost-effective solution for businesses seeking to improve their cash flow.

Debt-Free Funding

Factoring does not add debt to a business’s balance sheet. It is simply an advance on money already owed to the business through its invoices. In contrast, an MCA is considered a debt that must be repaid, adding financial burden to the business.

Improved Cash Flow Management

With factoring, businesses receive immediate cash for their invoices, allowing for better cash flow management. This enables them to meet ongoing expenses, invest in growth, and avoid the cash flow disruptions that can occur with the daily repayments required by an MCA.

No Negative Impact on Cash Flow

Factoring does not affect a business’s daily cash flow. The factor advances funds upfront and collects payment directly from the business’s customers. In contrast, MCA repayments are deducted daily from the business’s credit card sales, which can strain cash flow, especially during slower sales periods.

Credit Risk Mitigation

Factoring companies often conduct credit checks on a business’s customers. This not only helps mitigate the risk of non-payment but also provides valuable insights into customer creditworthiness. MCAs, on the other hand, do not offer this added layer of security.

Scalability

As a business grows and generates more invoices, the amount of financing available through factoring grows as well. This scalability is advantageous for businesses looking to expand, as it ensures continued access to necessary funds. MCA funding is usually capped based on past sales and doesn’t scale as smoothly with business growth.

Experience the Benefits of Factoring for Yourself

If it sounds like invoice factoring is the better solution for your business funding needs, we’re happy to match you with a factoring company that can help you maximize the benefits and offers competitive rates. Request a complimentary rate quote to get started.

Factoring vs. Merchant Cash Advance FAQs