Invoice factoring and merchant cash advance methods are used as business alternatives when a simple and quick process of funding and financing is required. These methods have fewer documentation requirements and process the application faster as compared to other traditional methods. Small business owners are going for these methods these days because of their simplicity and immediate response.
Invoice factoring and merchant cash advance are, however, different from each other because the funding sources are usually not equal. Thus, it is important to understand the nature of each type of funding source for the business.
What Is Invoice Factoring?
Invoice factoring is a process in which a factoring company purchases the invoices of your business. This method doesn’t involve any strict or regulated credit application requirements as compared to loans and offers fast cash options to businesses. Invoice factoring can sometimes be a better option for your business because of the following factors:
- Lower risk
- Faster cash access
- Lower cost
- Additional services
- Better financial solution
Invoice factoring allows a business to have working capital on an on-going basis so that a business owner can reinvest easily. Factoring involves giving cash to a business which it has already earned, so a business can receive a working capital which is very flexible and meets its financing needs. There are no risks or debts included with this type of funding. For small businesses, invoice factoring is much easier to get approved because it requires minimum credit details and the application process is quicker.
Though merchant cash advances are considered equal to invoice factoring, they involve more risk than invoice factoring. This is because factoring companies purchase your existing invoices and thus, the interest rates are lower too. You may also take advantage of the back office services because the invoice factoring companies buy your unpaid invoices.
Factoring companies also charge a very small amount, that is, a very low percentage of the total amount of invoice. The factoring fee is based on the invoice of a business, the credit rating, and the period till which the invoice will remain unpaid.
What Is Merchant Cash Advance?
Merchant cash advance (MCA) is a funding method which offers a certain amount of cash to a business on the basis of future credit card sales of the business. A certain period is set, for which the business will pay the installments of the advance. These installments are cut from the total percentage of the daily sales set by the funding source.
The cash collection process of this method seems very simple, so businesses which are struggling to get good financing solutions from the bank go for this option. This method of cash advance is, however, associated with high overall costs and rates.
A MCA provides quick access to cash, but on the other hand, it is not beneficial for a business in the long term. Mostly, the companies that are offering MCA buy a certain percentage of the business’ future sales. If you have chosen the option of MCA, you’ll have to pay installments of the loan on a weekly or monthly basis, which will be set by the funding source as a percentage of debit and credit card sales.
MCA is associated with higher costs and interest rates and is usually not recommended for a business to go for. If a business is in a situation where it needs quick access to cash, it can consider the option of going for this method of funding. This funding method involves an agreement between the MCA provider and the business owner over a projection of the future sales of the business.
Which Option Is Better?
MCA offers quick cash, but there are higher interest rates and long-term costs associated with it. Some business owners go for this option when they need immediate funding, but such businesses should also consider the high overall cost. Invoice factoring charges only a small percentage of the invoice and has lower risks associated with it.
If you want to choose between the two funding sources, you must consider the amount of working capital you need for your business.