How does a business cash advance work?
A business cash advance is a type of lending based on future revenue. It comes in a few different forms, the most common of which is aВ merchant cash advance, and might also be known as a revenue loan, a turnover loan, or revenue-based financing.
- Business cash advances
- Merchant cash advances
- Invoice finance
- Overdraft alternatives
What is a business cash advance?
A business cash advance is a type of lending based on a business’ future revenue. It comes in a few different forms, the most common of which is a merchant cash advance, and it is sometimes referred to as revenue loan, a turnover loan, or revenue-based financing.
A cash advance is different to a conventional business loan, because instead of having an outstanding navigate to the website loan amount, interest rate, and term, a cash advance effectively sells future sales to the lender at a discount.
This means the terminology used is a little bit different. For instance, the term вЂadvance rate’ is used instead of вЂloan amount. Let’s take a closer look at merchant cash advances for businesses to see how they work and what the benefits are.
With a standard business loan, you get a lump sum at the start of the term, and then pay interest for as long as that amount is owed. This concept applies to loans, overdrafts, revolving credit facilities, and lots of other types of finance — in fact, most of the common forms of finance work on this principle.
With a loan, the total cost of the finance — i.e. the interest you pay on top of the principal lump sum — varies depending on how long you take to pay back the loan. Business cash advances turn this idea on its head. Instead of having interest constantly вЂrunning’, the total cost of finance is agreed up-front. So instead of a monthly interest calculation, there’s a fixed finished line you need to get to. Here’s how it works in detail:
Business cash advance example
In this example, the lender offers to buy £12,500 worth of future sales for £10,000, at a repayment percentage of 20%. So £10,000 is what you get now, and £12,500 is what you’ll eventually pay back.
You might look at these figures and think “I’ll be paying 20% interest”, but that’s not the case. With a business cash advance, repayments are taken from your revenue — so the 20% figure doesn’t refer to interest, but rather the proportion of your revenue that will go towards paying back £12,500. Let’s see how this breaks down per transaction:
After these three transactions, you’ve made repayments of £ (2+26+). Of course, you’ll have more than three transactions in an average day — this is just a simple way to demonstrate how it works. The key point is that each of these transactions chips away at the £12,500 repayment amount — the finish line.
The crucial thing to understand about this method of repayment is that because it’s proportional, you pay back more when your revenue is higher and less when things are slow. But however it turns out, the total cost of finance doesn’t change — you’ll always be paying down £12,500, and there’s no compounding interest.
This method of repayment means that cash advances are more flexible than business loans, because instead of a fixed monthly repayment that has to be met regardless of your sales, the amount you repay goes up and down each month in line with your sales.
What is a merchant cash advance?
A merchant cash advance is a flexible type of business finance that is designed for companies and organisations that take card payments from customers.