In recent years, a type of Merchant Cash Advance known as a Business Cash Advance has been gaining popularity as a way to finance small businesses. Often, companies compare business cash advances against other products, such as factoring and purchase order financing, to determine which offers the best solution to their problems.
This article compares business cash advances against invoice factoring. It covers each product’s advantages and disadvantages. Once you have finished the article, you should have a good idea of which product is better tailored to your needs.
Definition: Business cash advance
A business cash advance is a specific type of merchant cash advance in which the lender finances your future sales. The lender reviews your financial statements and bank deposit track record to determine the maximum amount they can offer. Once the loan package is underwritten, the lender deposits the funds directly into your bank account. The lender makes periodic withdrawals from your bank account to repay the loan. The lender makes these withdrawals daily, weekly, or monthly until the advance is fully repaid.
Definition: Invoice factoring
Invoice factoring is a product that helps companies that have cash flow issues due to slow-paying commercial customers. In most commercial sales, clients pay their invoices in 30 to 90 days. This delay can cause cash flow problems.
The factoring company reviews the credit quality of your commercial invoices and provides an advance for invoices that qualify. This advance provides the funds to operate your company and secure new business. Each invoice financing transaction settles as your clients pay their invoices on their usual schedules. This type of facility can be used on an ongoing basis to improve your cash flow.
What problem are you trying to solve?
The financing product you deploy in your company should match the type of problem you are trying to fix. Loans are best used to buy items like supplies, equipment, etc. This is because loans provide a lump sum that is paid back over time. Revolving lines of financing, such as invoice factoring, don’t work well if you need to make a single large purchase. Instead, factoring lines work best to handle ongoing working capital needs.
Advantages of business cash advances
Business cash advances have some advantages, especially for small companies. Here are the three most important benefits.
#1 They are relatively easy to get
Most business cash advances are relatively easy to get. Your company just needs to submit some basic paperwork. Applications often include financial and bank statements.
#2 They can be obtained quickly
Lenders can process applications very quickly. Often, they can get your company funded in a few days. This rapid turnaround makes business cash advances an attractive alternative for companies that need funds quickly due to an emergency.
#3 They are available to companies that make retail or commercial sales
One important advantage of business cash advances is that companies with commercial and retail sales can use them. The use of factoring, on the other hand, is restricted to companies that handle commercial sales only.
Advantages of factoring
Factoring has several advantages, especially if your company works with commercial clients and has cash flow issues. Here are the most common benefits.
#1 It is easier to get than conventional financing
Getting a factoring line is easier than getting a bank loan or line of credit. The most important requirement to qualify is to have creditworthy commercial clients.
#2 It can be deployed quickly
Most factoring lines can be deployed quickly. The initial funding usually takes place in three to five days. Subsequent funding transactions can be done in one business day or less.
#3 It is flexible and grows with your business
Factoring lines are flexible and adapt to your business. Your line can increase, often quickly, to adapt to business growth and new sales. A factoring line can be an ideal option for companies that have cash flow problems because they are growing too quickly.
#4 Your past bank account history is not very important
Factoring can be used by companies that have had financial problems. Often, factoring is used by companies that are trying to turn around their business due to prior difficulties.
Disadvantages of business cash advances
Like every financial product, business cash advances have some disadvantages as well. Let’s explore the most common disadvantages.
#1 They have a fixed value
Perhaps the major drawback of a business cash advance is that it has a fixed value, much like a conventional term loan. Therefore, you must be able to forecast your cash needs accurately. Otherwise, you could end up with less (or more) money than you needed.
The fixed value of a business cash advance is not a problem if you need the funds to purchase equipment, since the cost of machinery is known ahead of time. However, it can be a problem if you need the funds to pay operating expenses, which can change with little notice (e.g., if you get an unexpectedly large order).
#2 They are hard to modify and increase
Business cash advances can be inflexible and hard to modify. This inflexibility can be a problem if you are in the middle of paying a loan and you need to increase your loan amount. Your lender won’t be able to provide additional funding until you pay off the previous loan. However, lenders can make exceptions in certain circumstances. Discuss this matter with your lender before getting the loan.
#3 They are comparatively expensive
Business cash advances, like most alternative solutions, are not cheap. The solution is more expensive than conventional loans and lines of credit. It’s generally considered more expensive than other solutions as well.
#4 You must be able to provide accurate financials
The lender bases its financing decision on a few criteria, including your corporate financial statements and your bank account track record. Actually, your bank account track record is one of the most important factors considered for this type of financing. The lender reviews past minimum balances and deposits to see if they can finance your company. This scrutiny can pose a problem for companies whose banking track records are far from perfect.
Disadvantages of invoice factoring
As you can imagine, factoring solutions also have some disadvantages. Here are some of the most important disadvantages of invoice factoring.
#1 It solves only one problem
Factoring your invoices helps you only if you have cash flow problems because clients pay receivables in 30 to 90 days. Factoring can help you pay operating expenses. However, it won’t be of much help if you need money to buy new equipment, make large purchases, or handle a single, large order.
#2 You must have good commercial clients
To qualify for invoice factoring, you must work with commercial clients with good credit. This solution won’t work well for companies that work with smaller businesses that don’t have a full credit profile. It also won’t work if you sell only to retail clients.
#3 It’s comparatively expensive
Factoring invoices is more expensive than conventional financing. It’s considered cheaper than business cash advances, though this assessment varies based on how the comparison is made and on individual circumstances. In general, factoring rates range from 1.15% to 3.5% per 30 days based on the volume of your account and the credit profile of your clients.
Which solution is better?
The better solution depends on your business type, current situation, and future needs. Factoring helps you if you have good commercial clients, growing sales, and need funds to operate the business. A business cash advance may be better if you have minor cash flow problems, run a stable business, or need funds to buy equipment or handle one big order.
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