In our third article about working capital financing, we would like to touch on a growing form of small business funding designed primarily for retail and service businesses.
All financing is based on a company’s ability to repay a business loan or line of credit. Some financing, like your standard term business loan, focuses on the company’s (borrower’s) ability to generate future, consistent cash flow from their overall business operations.
Other small business financing (like accounts receivable factoring or purchase order financing) focus on a single future cash event and advances working capital based on that event.
Financing for retail and service businesses, via Business Cash Advances, combine both – the business’s ability to generate a constant or growing revenue stream and its future cash events.
Business cash advances are not true business loans but cash advances based on the future credit or debit card receipts of a business.
(Note: For the remainder of this article, we will use credit cards to mean both credit and debit cards.)
These receipts come from customers making purchases in the business’s stores (online or brick and mortar stores) with credit cards in lieu of cash or checks.
When paying by credit card, a customer swipes their card in exchange of payment. At the end of the day or after a couple of days, depending on the business, the merchant company (any business that accepts credit or debit cards) will batch together all their credit card sales and submit that batch to their credit card processor.
The credit card processor will then remit payment to the merchant (the retail or service company) and then seek to collect payments from the individual credit card companies.
If a business can demonstrate (from past results) that it can consistently get customers to pay via credit cards in the future – then the business can factor those results into a business cash advance today – sometimes called a merchant cash advance.
The cash advance provides the business needed working capital to expand, purchase inventory, hire additional employees, increase marketing or for any need the business owner deems worthy.
A business cash advance financing company will look at past credit card receipts (say over the last 6 months). If these receipts are consistent or growing, they will assume that the business will generate this same level of receipt in the future (future cash events) and it is these future credit card receipts that can be used to repay the cash advance.
Examples: Let’s say your business generates $10,000 per month in credit card sales (and has done so over the last 6 months) and expects to continue this trend over the next year.
This business could receive $60,000 in a business cash advance (based on the next 6 months of credit card sales) or up to $120,000 based on the next 12 months of credit card sales to be used as working capital.
Repayment of the advance is not set as a fixed payment. It is based as a percentage of all future credit card sales until the advance is repaid in full to include any financing charges.
In order to ensure that repayment does not harm the business’s ability to generate future sales (as that is where repayment comes from), the repayment amount is set at 5% of the business’s daily credit card receipts.
Therefore, the day after the business receives the cash advance; it generates $350 in credit card sales. From that $350, the financing company takes $17.50 (5% of $350) and remits the remaining amount ($332.50) to the company. This will continue until the advance is repaid in full.
This means that the business owner still has access to 95% of all future sales; allowing the business to use its own cash flow from operations to cover its immediate obligations and not requiring the business to use the business cash advance for anything other then what it was intended.
Moreover, since repayment is based on future sales, if the business has a slow month, the repayment is still only a small portion of those sales and not a fixed amount. Unlike bank loans, whose repayments are fixed each month (regardless of sales or revenue volume), here, if the company’s revenues are down it still only pays 5% of that revenue – again not putting additional burdens on the business should sales slump a bit.
From our example, when daily credit card sales were $350, the company made payment of $17.50. But, if credit card sales drop to say $250 for a day or two, the payment is not the same $17.50 but only 5% of the daily credit sales or $12.50.
Why are business cash advances the perfect working capital vehicle for retail and services businesses?
Three primary reasons:
- Retail and services businesses tend to accept credit cards as payment from their customers – more so then manufacturing and similar companies.
- Retail and services businesses tend to have large inventory requirements with inventory purchases being made with the seasons – something that business cash advances are designed to finance.
- No collateral required as most retail and services businesses have little collateral to offer that is valuable enough to secure a traditional business loan.
If your business has had some success in the recent past and thinks that it could do better moving forward yet does not have the capital on hand to realize that opportunity, then why not use all the resources it has at its disposal?
Business cash advances are excellent working capital financing vehicles allowing retail and services businesses to either build needed inventories or expand their capability to meet more customer needs.