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 businessвЂ™ 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 rateвЂ™ is used instead of вЂloan amount. LetвЂ™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,В overdrafts,В revolving credit facilities, and lots of other types of finance вЂ” in fact, most of the common forms of finance work on this principle.
With a loan, the total cost of the finance вЂ” i.e. the interest you pay on top of the principal lump sum вЂ” 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 вЂrunningвЂ™, the total cost of finance is agreed up-front. So instead of a monthly interest calculation, thereвЂ™s a fixed finished line you need to get to. HereвЂ™s how it works in detail:
Business cash advance example
In this example, the lender offers to buy ВЈ12,500 worth of future sales for ВЈ10,000, at a repayment percentage of 20%. So ВЈ10,000 is what you get now, and ВЈ12,500 is what youвЂ™ll eventually pay back.
You might look at these figures and think вЂњIвЂ™ll be paying 20% interestвЂќ, but thatвЂ™s not the case. With a business cash advance, repayments are taken from your revenue вЂ” so the 20% figure doesnвЂ™t refer to interest, but rather the proportion of your revenue that will go towards paying back ВЈ12,500. LetвЂ™s see how this breaks down per transaction:
After these three transactions, youвЂ™ve made repayments of ВЈ (2+26+). Of course, youвЂ™ll have more than three transactions in an average day вЂ” this is just a simple way to demonstrate how it works. The key point is that each of these transactions chips away at the ВЈ12,500 repayment amount вЂ” the finish line.
The crucial thing to understand about this method of repayment is that because itвЂ™s proportional, you pay back more when your revenue is higher and less when things are slow. But however it turns out, theВ total cost of financeВ doesnвЂ™t change вЂ” youвЂ™ll always be paying down ВЈ12,500, and thereвЂ™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.