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In the previous article, we understood what a merchant cash advance is. We also understood the two types of merchant cash advances that are available in the market. Even though merchant cash advance is considered to be a financial innovation by some people, it also has its fair share of critics.
Hence, for a business, it is very important to understand and weigh the pros and cons of a merchant cash advance before making a decision.
This article will explain the pros and cons of merchant cash advances in great detail.
A merchant cash advance is used by many companies because it offers a wide variety of benefits. Some of the common benefits have been listed below:
Therefore, the repayment rate increases or decreases based on the sales performance. This gives the borrowing company some flexibility to structure its other expenses.
Also, the possibility of defaulting on a merchant cash advance is quite low since the loan is created in a way that it automatically adjusts with changes in cash flow.
Generally, a lot of time is required to disburse bank loans. However, merchant cash advances can get disbursed almost instantaneously. This is the reason why many businesses are willing to pay a higher monetary cost to avail of such loans.
However, when it comes to merchant cash advances, banks typically have visibility into the average sales data of the firm. This is because they provide the point of sales systems that process such payments for the customer.
Therefore, commercial banks do not ask for documents such as balance sheets and tax statements in order to process the loan. Since they have complete visibility over the cash flow situation at the firm, they are able to disburse the loan with more certainty about its repayment.
Hence, if a company is experiencing poor sales, they just take longer to pay the loan and pay more interest on it. There is no need for a formal restructuring since the loan restructures itself as and when required.
Merchant cash advances have also faced a lot of criticism because of the various pitfalls which are associated with them. Some of the issues have been mentioned below:
It is important to note that only businesses with very poor cash flow management opt for such loans. Since these loans are considered to be the commercial banking equivalent of payday loans, mega corporations generally try to avoid taking such loans.
Due to lack of regulation, the state usury laws do not apply to these advances. As a result, it has been alleged that some commercial banks have used these loans as predatory lending products to target small and medium enterprises.
However, after that if they face an unforeseen circumstance or if they face setbacks in business, they are forced to resort to merchant cash loans again. A very large number of businesses that utilize the merchant cash advance facility find themselves in financial trouble.
Apart from that, a wide variety of fees and charges are levied on these loans. This makes these loans quite complicated. Many small businesses do not have finance departments that are equipped to deal with such loans. As a result, they often face difficult situations after taking these loans.
The fact of the matter is that merchant cash advance is a controversial product created by commercial banks. Some businesses are more concerned about its advantages whereas others choose to focus more on the disadvantages. It is up to each business to make its own choice based on its own priorities.
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