If you are a business owner looking to infuse some quick cash into your company, you have many options to choose from, including merchant cash advances and account receivables factoring. What are the two financing methods and how are they different?
How Does Factoring Receivables Compare?
Merchant cash advances offer a bulk payment upfront for a return of a percentage of the business’s projected sales. Though rates vary, according to Businessweek.com the premiums for cash advances average around 30% so users of cash advance services tend to be in a high-needs situation though this is not always the case. Neither invoice factoring companies or merchant cash advance companies offer “loans” though both are often confused as doing so. Some sectors more heavily rely on merchant cash advances, such as those in the service, restaurant or retail. Businesses such as these that depend heavily on credit transactions are more likely to be in a cash-strapped situation though they have credit payments coming in.
How Do Invoice Factoring Services Differ?
Invoice factoring or factoring receivables also offer a large, bulk payment upfront but use a company’s existing invoices rather than future sales projections. That is, a factoring company will use your current invoices for collateral and provide you with their current value minus a percentage, which averages 2-8 percent plus ongoing monthly rates. Factoring receivables tend to charge much less than merchant cash advances, usually 22-27 percent less. Also, It is significant to note that factoring services work against your current invoices rather than an estimated, projected dollar amount. So let’s say you get factoring services for $10K worth of invoices, money that you know you have coming to you. The factoring company charges you a rate of 4 percent, which means you basically pay out $400 on the spot to get your money now.
Invoice Factoring Uses Current Numbers Rather than “Projections”
Using this same situation with merchant cash advance service…you predict future sales of $10K and the merchant cash advance company charges you a rate of 25 percent, which means you will pay $2500 to get your money now. However, because the agreement was based on a prediction rather than an actual amount, it could end up costing you more. Let’s say the future sales are actually only $8K. But according to Inc.com, you are still contractually obligated to pay based on the future sales amount of $10K. Depending on how long it will take to generate the actual sales figure, you could end up having to pay a lot more. In short, both invoice factoring and merchant cash advances can provide businesses with cash quickly but invoice factoring charges lower rates than merchant cash advances because it is based on existing invoices rather than projected sales.