As business owners we all understand that there are times extra cash is needed for the business. The typical routes to getting money are through bank loans, personal loans back to the business, SBA loans, or other financial implements. However, what do we do if these aren’t an option? In the world of merchant services, there is another alternative called the cash advance.

Can a cash advance be a good choice for a business with a need for cash? Let’s start out by reviewing what is a cash advance and then consider two real world cases of business owners using a cash advance.

A cash advance is a financial tool that a business owner with good cash flow can use to access money. It is not a loan, but a selling of future credit card receivables. The money is typically available within several business days and doesn’t usually have either a lot of paperwork or a personal guarantee associated with it.

Repaying the cash advance is most often done daily where a fraction of the money received in credit card sales (credit card receivables) for the day are directed to the company that provided the cash advance.

To determine how much of your receivables to purchase or how much of an advance you qualify for, a cash advance company will want to know your industry and your overall cash flow, not just your credit card volume. Your overall cash flow helps the cash advance company determine an upper limit to the receivables that they will purchase from any business. Additionally, your type of industry lets them know how tied up your cash flow is (restocking inventory, operating expenses, etc.) and will help them set a more reasoned limit of how much of your receivables they will purchase. As an example, tire shops have a slim margin on their product and have a difficult time qualifying for more than a fraction of a single month’s receivables. Veterinarians, on the other hand, have a much better profit margin and often qualify for more than a single month’s receivables.

How are payments calculated?

First, since this is not a loan, there is no interest and there are no restrictions on the amount the cash advance company can charge for you to “use their money”. Instead, the repayment is based upon a factor. As an example, if you have a factor of 1.3 and the amount funded was $10,000 the total payback is $13,000. I have personally seen factors ranging from 1.25 to 1.42. As you can see, this money is expensive.

Second, the cash advance company will consider the time allowed for the repayment. This is typically between 9 and 48 months with a preference for the shorter timeframes that can be reflected in a lower factor.

Lastly, the cash advance company looks at your average daily receivables in credit cards and calculates the percentage needed to pay them within the time agreed upon.

Now that we know what a cash advance is and how expensive the money can be we need to answer the question. Is it worth doing. To answer that question, I am going to give two examples where I personally worked with the business owners getting the cash advance.

In this first example, I worked with Joe (not his real name). He owned three locations selling oils and fragrances. All his businesses were in tourist destinations, and he had an average monthly cash flow of approximately $50k per location. He was interested in opening another location, but could not convince his bank to lend him the $250k that he needed to cover opening costs and inventory for the new location. So, he spoke with me about a cash advance. I had him leverage the cash flow from his 3 existing locations to secure the advance. And by the third month of operation his fourth location was doing enough business that he asked to accelerate his payback and get a lower factor. This is something that we discussed with the cash advance company up front, and they had agreed to do. As you can see, although the money was expensive, the payoff was enormous. Fantastic!

This next example I will label as folly and to this day I am not sure why Gary (not his name either) did this. Gary called me to borrow money for his business. It was not a huge amount. He was only asking for $15k. His factor came in at 1.37, so that his final payback was $20,550. As I recall, his daily payment was about 10% and he paid the cash advance company back within six months. However, I found out later that he used the money for a vacation. He removed money from the business and got no real benefit for the business, and he paid ~$5k to do so. Had he used a personal credit card with an interest of about 14% APR and waited 6 months to pay it off, his cost to finance the vacation would have been about $1,500. There could be reasons that I am unaware of that made this attractive to Gary, but from a purely business perspective I can’t understand why anyone would use a cash advance in this manner.

This experience with Gary taught me a valuable lesson. I make sure that anyone considering a cash advance understands that it is expensive money. That it can be a valuable business tool, but that you must have a clear objective. You must be able to show how expensive money today benefits your business tomorrow. By answering this one question, you can go from folly to fantastic!