A merchant cash advance (MCA) acts as a working capital loan in certain situations. Remember that an MCA is not a typical loan, rather it is an advance against future cash flow. This kind of funding allows a business to position a portion of its revenue to pay back the advance while leaving the business financially solvent.
In this respect, the concept of “working capital” refers to the idea that since the remittances are the basis for underwriting, it's assumed the business has the ability to comfortably pay back the advance. The more business that a business does, the more of a chance that the business will have access to the capital they need. MCA’s can be helpful during periods of unexpected downturns, when upgrades are required to equipment or to cover temporary shortfalls. Because the payback periods are typically fast, it’s important to not overextend the business or view this as a windfall.
Here’s an example of how to properly utilize a cash advance:
ABC Pizza is a favorite haunt for the locals. The owners of ABC support the local little league ball club, raise money for scholarships and donate pizza for all the school events. ABC’s signature pizza recently became a phenomenon when a celebrity posted a picture on Instagram. The owners were able to market their newfound celebrity to a wide audience that requested frozen pizza to be shipped all over the world.
As a result, demand has surged and the owners have decided to expand by taking over a vacant storefront next door and building out a dining room and a small warehouse to ship their now-famous pie.
But its owners didn't foresee that amidst the expansion, its existing equipment needed upgrading. They had talked about it for many years but had not gotten around to it. With the peak season about to begin, any potential equipment failures were an unacceptable prospect. Unfortunately, this was easier said than done given the considerable financial resources spent towards the new expansion.
Given that ABC Pizza does nearly $50,000 dollars a week on average, an $80,000 fast turnaround loan for its new ovens and stoves was not practical. And because the owners sunk so much money into shipping containers and the new lease, they were cash strapped.
The owners then took a merchant cash advance, as they projected the expansion would add another $20,000 to the weekly bottom line and the loan could be repaid within six months. A lender negotiated a 1.25 factor rate for ABC Pizza, which cost the restaurant $100,000 in repayment. Averaging out over a six-month term, the loan would cost over $800 a day.
With the new equipment and renovations, ABC Pizza was able to offer both local delivery and online ordering services of its famous frozen pizza. All these efforts increased their weekly bottom line by 10% over its projections to $90,000 a week. Best of all, ABC Pizza was able to maintain its quality, atmosphere and traditions while having a quick source of capital that didn't leave a bad taste.
As usual, we cannot stress the importance of “knowing your numbers.” A Merchant Cash Advance can be an extremely effective weapon in your strategic planning arsenal. But like any weapon, it’s not appropriate in every situation. A good broker will walk through your financial projections to make sure you can handle repayment terms and ensure that an MCA is the right fit for your business. Never take an advance or any type of loan based on hope (i.e. “I hope I can pay this back!”) Know your numbers, be confident in your ability to pay back the advance and invest the working capital where it has the greatest potential.