It has always been the practice of business owners to seek loans once there is a need for capital which the business cannot raise at the moment when needed. It is also true that the whole process of obtaining loans especially from commercial banks can be anything but simple and straightforward.
In most cases, the loans come at such a huge time cost, or it often happens that the banks require huge collateral which the business might not be able to provide. However, Merchant loans from reputable merchant cash advance companies are quite the opposite of what could be obtained in the traditional bank loan context.
Unlike traditional loans, merchant loans are quick to access and it is not surprising why it readily comes to mind when a business is seeking immediate financial assistance. And, of course, it is necessary to examine how this particular method of obtaining business fund works.
How do they really work?
Financial experts will always agree on one thing: merchant loans are not loans in the traditional sense of the word but are simply cash advances given in exchange for the future credit sales of a business franchise. This is to say that the lending firm, one which provides the cash advance, does so with the hope of recouping its investment and making some profit in the process.
So to understand how a merchant advance works let us take the business firm seeking the fund to be a small instruments company which is looking to invest in new machinery to increase its production units per day. In this scenario, it can be assumed that the decision to increase output was motivated by some recent upsurge in demand.
In any case, since the company lacks the capital for such machinery, and because the need is urgent it decides to get a merchant loan. Let us also assume that prior to this time the company had revenue of $40000 a week. However, the company anticipates that purchasing additional units of machinery will likely increase revenue to $100000 a week. So it gets a $200000 advance to purchase the machines.
The lending firm so to speak then multiplies this amount by a certain factor let us, in this case, take that to be 1.2. This means that the total amount to be repaid by the business firm is $200000* 1.2 which is $240000. This is amount is to be recovered from the future credit sales of the company in a manner that has been agreed to by both parties.
Unlike commercial bank loans, however, merchant loans are not usually spread out over a long period of time, and as such are usually repaid within 6 months or thereabouts.
What is the payment method?
The most common method of payment is the one based on the percentage of credit card sales. In this method, the lending firm chooses to charge the advance against, for instance, 20% of the future credit sales of the firm. So for our hypothetical instrument firm that envisages revenue of $100000 a week after acquiring the new equipment, (let us assume once again that this does in fact happen), the amount to be deducted from this firm is $20000 a week.
Of course, it is also possible for this deduction to be made on a daily or weekly basis; but whichever is the case the revenue is calculated for that period while the 20% percentage deduction is made. It can be seen that if this method is used the entire advance will be repaid in just 12 weeks all things being equal.
This method is quite favorable since the advance gets to be paid quicker if the business booms and sales exceed that estimated. And if it happens that sales fall below expectation, the period is automatically extended to allow for this. After all, there is no reward or benefit from quickly repaying a cash advance as opposed to what obtains with a conventional bank loan.
The other method is that of fixed withdrawal. In this case, the lending company computes the 20% based on the projection credited card sales of the instrument which is pegged at $100000 a week. But unlike the preceding method, the $20000 that is arrived at is paid whether or not actual sales fall below this estimate or not. As with the previous method, payment is made in a fixed interval that both parties have consented to.
This method provides that the loan is paid at the stipulated time without regard to what happens to credit sales. It is likely that this payment method will be more favorable to the lending firm that the business while it will tend to strain the cash flow of a business if the credit sales plummet.
Pros of merchant loans
The number one thing that makes merchant loans really attractive is the speed with which the cash advance can be obtained. Sometimes it could take less than a week to secure an advance. This starkly contrasts with almost the endless waiting associated with commercial bank loans which might not even be issued at the end of the day.
Unlike in commercial bank loans where a good credit score is required, issuing merchant advances is made without regard to credit score so that even a bad score will do just fine. In short, the chances of getting a cash advance request approved is much higher than that which can be obtained from most other sources and all this adds together to make the process free the normal delays associated with other methods of funding.
One other thing that makes merchant loans enticing is that there is no requirement for collateral. And if it occurs that the business winds up and was unable to repay the advance, there is often no way for the lending firm to recoup its investment: the lending firm loses.
In addition, if the payment method is that based on a percentage of future credit sales, then the payment will be adjusted based on how well the business is doing. Such that if the credit sales go down, the actual payment goes down and the time frame for the completion of the payment is expanded to accommodate this.
Cons of merchant loans
In the real sense of it, merchant cash advances are not cheap, at least in the long run. When compared to loans from most other sources, merchant loans are seen to generate high interest rates that can vary from lender to lender. Although some of these interest rates can be high, many people only have merchant cash advance as a source of funding for their business due to a bad credit score making this the best alternative for those kinds of businesses.
There is also a hidden danger in having the firm`s credit examined even though it is believed that cash advance is made without regard to the how good the credit score is. But most merchant loan providers will often perform background credit checks and this inquiry could easily result in a hard credit check and this might negatively impact the credit score. Although many businesses seeking merchant cash advance options already have a low credit score.
Speed and ease are the first things that come to mind when businesses are looking to raise working capital. In this regard, Merchant loans seem to be the answer. But Firms should always examine to see if the option of merchant cash advance suits their long-term objectives. And, of course, in most cases, it does.
After a thorough examination of the immediacy of the need for capital and the sufficiency of credit card accruals in the future, merchant loans proffer very quick options to obtain money in a jiffy and kick of business operations.