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 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 ‘advance rate’ is used instead of ‘loan 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 ‘running’, 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:
Advance amount: £10,000
Amount repayable: £12,500
Monthly repayment percentage: 20%
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:
Customer 1 pays £10; you keep 80% (£8) and the lender gets 20% (£2)
Customer 2 pays £129.99; you keep 80% (£103.99) and the lender gets 20% (£26)
Customer 3 pays £450.96; you keep 80% (£360.77) and the lender gets 20% (£90.19)
After these three transactions, you’ve made repayments of £118.19 (2+26+90.19). 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.
A merchant cash advance is a flexible type of business finance that is designed for companies and organisations that take card payments from customers.
It works by the business borrowing a sum of money which is subsequently paid back through a portion of the business’ customer card payments. A merchant cash advance can be used for any purpose, from inventory purchase to business growth.
Merchant cash advances are a convenient and accessible option for SMEs because the way they are designed can make them easier to manage. As the unsecured finance is repaid via card payments, it can also be a more affordable and adaptable option.
Business borrowers don’t have to navigate fixed monthly payments as they would with a traditional business loan. Every time a customer uses the card machine, a percentage is automatically transferred to the lender.
As such, the more money the business earns through card payments, the quicker it pays off the cash advance. Of course, it works the other way around too.
One of the first things to consider is how much you want to borrow for your business. This depends on what you plan to use the money for.
For instance, if you need to buy some equipment or a specific product or service you can make a fairly accurate estimation. However, if you’re planning to use it for a renovation or business growth you may need to do a little more planning.
The lender will take your average monthly turnover into consideration to work out how much you’ll be able to repay comfortably. There are a few options out there and each provider offers something different. For instance, repayment lengths can vary, as can interest rates and T&Cs. Funding Options can help you search the market to find an option that aligns with your needs and circumstances.
Funding Options works with 100+ lenders and our award-winning smart technology searches the market to find the right funding options for your situation. It takes minutes, there’s no obligation and it’s easy to use. To get an instant comparison, you just need to tell us how much you need to borrow, what it's for and also provide some basic information about your business.
Merchant cash advances work by the lender ‘advancing’ you the capital amount that you want to borrow and are eligible for. A percentage (typically around 10%) is taken from your card payments to go towards the merchant cash advance repayment. In other words, 10% will automatically go to the lender, while your business keeps the remaining 90%. The lender will usually provide you with access to an online platform where you can see how much you’ve paid back.
At the end of the day, businesses can have good and bad months due to seasonal peaks and dips, the state of the economy and other things that might be out of the individual’s control. With merchant cash advances, the amount you pay back coincides with what you earn, which goes some way to relieving the financial pressure on your business.
Merchant cash advances come with a variety of benefits, including:
More flexible - Your business only pays back the loan when it takes customer card payments, meaning that repayments correspond with your sales.
Quick to access - Depending on the lender and application process, you can get approved for a merchant cash advance within just 24 hours.
No need for security - Merchant cash advances are a type of unsecured business finance, meaning you don’t need to secure it with collateral. This is a perk if you don’t have many assets.
Easier application process - When applying for a conventional loan, traditional lenders may require a business plan, however merchant cash advance lenders don’t.
Instead, they look at your merchant statements to get an insight into your business’ sales records. What’s more, the lender may be able to access your merchant account statements online, which saves you having to submit them via email or post.
Credit ratings are not as relevant - Compared with other types of business finance, your credit rating isn’t as much of an issue because the funding is secured by the lender having access to your account.
Can carry less risk - As the repayments are automatically taken from the money you receive from customer card payments, there can be less risk of ‘defaulting’ on your loan and incurring fees such as penalty charges than with other types of business finance.
Transparency - The total amount you pay back doesn’t change - the lender will tell you what the total cost is when you take out the cash advance.
Merchant cash advances are by far the most common form of business cash advance, because the payments technology makes it very straightforward to track. They’re designed specifically for merchants — in other words, businesses that take payment using a card machine — and the lender works with your payments provider to be directly involved with each transaction.
The advance amount is usually based on your average month’s turnover, so the lender will want to see your last few months of card sales. As with the example above, you’ll have an advance amount and an agreed repayment percentage.
The main advantage of merchant cash advances specifically is that once they’re set up, they require very little oversight. There’s no monthly repayment to worry about, because every single transaction pays down the debt, and you’ll know the total cost from the beginning.
Business owners often find that the repayments feel painless too, because rather than putting money aside you just carry on as normal, and the advance is automatically repaid. Most merchant cash advance providers offer an online login where you can see the status of your advance, and many will offer top-ups once a certain portion has been repaid.
Although it’s not technically a type of business cash advance, invoice finance is worth mentioning here, because like these other products it works by selling something to the lender at a discount — namely, accounts receivable in the form of unpaid invoices. In fact, this is where ‘invoice discounting’ gets its name. Read our invoice discounting page for an example of how the pricing works.
The key point about invoice finance is that if your customers owe you money, you can get most of the value of these invoices from the lender within a day or two, and then the remainder minus fees once your customer has paid. If your business operates in an industry with long payment terms like recruitment or construction, invoice finance is a useful way of smoothing out cashflow bumps and making things a bit more predictable.
If you’re looking into business cash advances because of flexibility, it’s also worth considering overdrafts, business credit cards and their alternatives like revolving credit facilities. All of these products give you a pre-approved credit limit that you can use as and when you need — so they’re a useful safety net to have in place.
One downside compared to business cash advances is that the amount you can borrow might be lower, and the cost varies depending on your usage.