How Does a Merchant Cash Advance Work?

For many businesses, a merchant cash advance represents an opportunity to take advantage of a short-term opportunity by maximizing the cash on hand when it’s time to renovate, redecorate, or restock. The flexible working capital it provides can cover everything from additional staff to short-notice product orders, but it’s not always the most cost-efficient way to access capital. Using an MCA effectively means understanding when it is used most effectively, and to do that you need to know how it works.

Holdback and Interest

Since a merchant cash advance is based on the income you get from electronic transactions paid into your merchant account, it only works well for businesses that count on a high volume of credit card sales. The advance is not structured with a standard amortizing payment, instead the payment is expressed as a percentage holdback. This percentage is the portion of the account’s income that is paid to the lender each month, and the idea behind holdback is to keep payments manageably low when business is slow while making it easy to pay back the advance quickly as soon as you hit your boom. Interest rates on MCAs can be quite high when viewed as an annual percentage, but when used as a short-term cash advance designed to pay itself off in under 90 days, it can be the most cost-efficient way to get that working capital you need.

Can You Manage Cash Flow With an MCA?

Some companies do manage cash flow with regularly timed MCAs. Typically, these businesses have predictable cycles that allow them to load up on stock just before a demand boom, which then pays off the MCA. The profits then provide working capital during the season and the first part of the cycle’s slowdown, before another merchant cash advance provides the income needed to restock without depleting company cash reserves. Outside of that narrow structure, the MCA is more cost effective as a tool for taking advantage of short-term demand surges and other opportunities with a payoff on the immediate horizon. By using them in combination with regular cash management tools like business credit lines or working capital loans, you can structure your financing to suit the situation, making it easy to access capital at the lowest cost possible no matter what you need it for.

There are a lot of options for regular cash flow management to cover your core overhead that have lower annual interest costs than an MCA, but there are very few that will provide you with approval as quickly when you need fast cash because you see an opportunity on the horizon. Keep that in mind when you see a busy holiday season coming up.