Pros and Cons of Merchant Cash Advance
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.
Benefits of Merchant Cash Advance
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:
- Flexibility: The first and most important benefit of a merchant cash advance is that this type of financing is quite flexible. This is because in most cases, the commercial bank charges a percentage of sales as their repayment rate. 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.
- Faster Access: Many businesses find merchant cash advances to be very helpful because these advances can be obtained at very short notice. The alternative to a merchant cash advance is bank loans. 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.
- Easy to Obtain: Generally, business loans are provided based on the balance sheet and tax returns of any company. This makes business loans harder to obtain. 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.
- Lower Risk: The merchant cash advance has a lower default risk for the bank as well as the customer. This is because the repayment adjusts itself based on the cash flow situation at the company. 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.
Disadvantages of Merchant Cash Advance
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:
- High Cost: Merchant cash advance loans are available at a significantly higher cost as compared to other loans. The annual percentage on these loans can run into higher double digits. This is the reason that these loans have come under heavy criticism. 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.
- Low Regulation: Merchant cash advances have some of the lowest regulations in the world. This is despite the fact that the merchant cash advance industry is bigger in size as compared to payday loans and also charges a higher annual percentage rate.
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.
- Debt Trap: The high-interest rates charged on merchant cash advances sometimes make businesses desperate to get out of these loans. Hence, businesses often resort to taking funding at unconventional terms in order to pay off these loans. 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.
- Complicated: Merchant cash advances can also be very complicated instruments. This is because they have a variable cash outflow. Also, it is possible that the banks may charge a higher interest rate if the cash outflow falls below a certain threshold. 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.
Authorship/Referencing - About the Author(s)
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