Commercial Factoring vs. Merchant Cash Advance: Learn the Difference

One of the most common questions asked by small business owners when exploring their financing options is whether factoring or merchant cash advance is the best way to solve your company’s cash flow problems when you’re in need of quick capital.  This is a common question asked by all business owners and our financing prospects and it is important that you learn a little about these popular financing tools.  So, lets take a look at a side by side contrast and comparison of these two popular funding solutions and then you be the judge as to which is most advantageous for your business.

Are These Financings Apples to Apples?

When you first begin to compare factoring vs. merchant cash advance (and we will include ACH financing as well), the first important concept you need to understand is what kind of financing is this?   Both of these financings are considered “off-balance sheet” because neither are considered loans against a business asset.  They are both an “advance”.

  • Factoring is:  the purchase of the current invoices of a business and as such, it is only available to business that operate B2B.  The factors advance is a purchase of the business accounts receivable.  It converts an account receivable to immediate cash.
  • An MCA / ACH is:  an advance on future and anticipated sales revenue and usually from credit card sales or over the counter cash sales.  Although it can also represent invoice sales as well, the MCA / ACH provider is NOT a buyer of the sales because they do not yet exist.  It only advances on anticipated sales based on anticipated historical data.

So while both compare as a source of business funding, the contrast of the two is significant.  A factor advances as a purchase mechanism on existing sales that were invoiced.  These are sales that already exist and have generated an identifiable income for the business that can be counted on.  MCA and ACH financing represents cash that is projected as a “best guess” of future credit card sales or over the counter sales.  

Another way to compare these two financings is that factoring as a method that a business owner uses to finance its “loan business“.  Factoring is used to finance the business’s “terms of payment”.  When a business offers 30, 45, or even 60 days for a customer to pay an invoice, that business is actually providing a short term loan to its customer.  Such invoice “loans” to customers are part of the working capital of a business.  Factoring is used literally to accommodate those invoice loans to customers.  And, as a additional benefit, such liberal payment terms lead to more customers and larger orders.

Financing companies offering MCA and ACH financings have nothing to actually purchase or loan against.  It is, to some extent, high risk “crystal ball financing” which is offered to typically non-bankable business owners in need of new capital.  Unlike finance receivables to “recoup” loaned capital to customers, merchant cash advance funds represent “new” capital.  It is most often used for some business equipment that will lead to more sales or used for a location upgrade or similar.  MCA and ACH advances are seldom used for (or should they be) financing current invoices for B2B business owners.   They are much more often used to finance consumer service businesses such as restaurants, convenience stores, gyms, and other consumer retail operations.

Client’s Risk of Repayment of the Advance

All advances, whether through factoring or through merchant cash or ACH advances, must be repaid.  Here, in the risk to lender area, factoring simply wins hands down as an option since the only risk a business owner shoulders regarding repayment of the advance to the factor, is the risk that an invoice is declined for payment by a customer because of a trade dispute or if a customer actually goes bankrupt while an invoice is being financed.   But, these situations are rare and factors additionally review the credit of the customers of a business prior to financing.  So, the repayment for the factor’s advance as part of the purchase of the invoices is assured.

In contrast, an MCA or ACH advance financing is always has the repayment risk due to a decline in future sales of the business.  For example, what if your business suddenly faces a competitor that cuts their pricing and forces you to do the same?  Future sales are at risk.  Profits are also at risk and not assured. And now, the ability of the repayment of the advance to the financing company is anything but assured.  Evidencing additional risk, the MCA provider typically automatically draws its portion of daily sales cash, known as the retrieval rate, out of the business’s bank account.  If the sales are down and cash is not available, serious penalties for the business owner can apply.

Financing Our Clients:  Factoring vs. Merchant Cash and ACH

So when do we recommend factoring to a one of our clients and when do we recommend an MCA or ACH advance?  As a valued consultant to you, our client, our expertsie and knowledge in this area is important. We very often know our business owners will be, to some extent, depending on us.  And our general rule is this.

If our client’s business operates business-to-business B2B, generates invoiced sales, and traditional bank financing is not an option, you will find we almost always recommend factoring since it is much less costly to the business owner.  

For our clients in need of capital that do NOT operate as B2B are typically recommend an MCA as an option.  Additionally, more and more providers of the MCA-styled product are now offering SBA loans, asset-based loans, and SBA Microloans for that that qualify.   

The good news is that the vast majority of B2B businesses qualify easily for a factoring arrangement so long as their invoices are not pledged for some other pre-existing loan to another lender.  Factoring is also relatively inexpensive when compared to MCA and ACH advances and it also provides many additional benefits to the owner.

MCAs are NOT loans.  We continue to view MCA’s as short-term capital options for business emergencies or for business expansion or non-leasable equipment purchase.    Understand that there is a place and time when MCA and ACH advances can be used very successfully and especially in retail so understanding MCAs and when to use them can open expansive doors for our clients that do not operate B2B.  MCA’s often represent start up capital for many small business owners and especially retail.  These are companies that can often grow exponentially if provided with such “seed” capital.  In many cases, such businesses will quickly become more bankable and can provide you with additional options such as an SBA loan down the road.

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