303: Continuing Education

Factoring vs. MCA or ACH

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Factoring vs. MCA / ACH

Factoring involves selling invoices to improve cash flow, while a Merchant Cash Advance involves receiving an upfront cash advance based on future revenue. The choice between factoring and MCA depends on the specific needs and circumstances of the business, including the nature of its revenue streams and the desired use of funds. Businesses should carefully consider the terms, costs, and implications of each financing option before making a decision.

Factoring vs. MCA / ACH

Factoring and Merchant Cash Advance (MCA) are both financial arrangements that provide businesses with quick access to cash, but they operate differently and serve different purposes. Here are the key differences between factoring and Merchant Cash Advance.

Discounting vs. Add-on Fees

Factoring is often described as a “discounting” transaction because it involves selling accounts receivable (unpaid invoices) to a third party, known as the factor, at a discounted rate. When a business engages in factoring, it essentially receives an immediate cash advance, but the factor deducts a fee or discount from the total face value of the invoices. This discount reflects the factor’s compensation for assuming the responsibility of collecting payments from the business’s customers. The factor takes on the credit risk associated with the customers paying their invoices, and the cost of factoring is determined by a combination of fees and discount rates applied to the total invoice amount. The business receives an upfront infusion of cash to address immediate financial needs, and the factor subsequently collects payments from the customers, releasing the remaining balance to the business after deducting the agreed-upon fees and discount.

On the other hand, a Merchant Cash Advance (MCA) or Automated Clearing House (ACH) loan involves a transaction with fees added on rather than a discounted rate. In the case of an MCA, a lump sum cash advance is provided to the business, and the repayment is structured as a percentage of future credit card sales or fixed daily/weekly debits from the business’s bank account. The cost of the advance is typically expressed as a factor rate, which is a multiplier applied to the advance amount. Similarly, ACH loans involve fixed daily or weekly withdrawals from the business’s bank account to repay the loan, with interest applied to the outstanding balance. In both cases, fees and interest are added to the original advance amount, constituting the cost of capital for the convenience of quick access to funds. These fees and interest payments distinguish these transactions from factoring, where a discount is applied to the face value of invoices.

Nature of Transaction:

    • Factoring: Factoring involves selling accounts receivable (unpaid invoices) to a third party (the factor) at a discount. The business receives immediate cash for the invoices, and the factor assumes the responsibility of collecting payments from the customers.
    • Merchant Cash Advance: MCA involves receiving a lump sum cash advance in exchange for a percentage of future credit card sales or a fixed daily/weekly amount from the business’s bank account. It’s not a loan but an advance against future revenue.

Collateral and Credit Check:

    • Factoring: Factoring is more focused on the creditworthiness of the business’s customers (the payers of the invoices) rather than the business itself. The factor assumes the credit risk associated with collecting payments.
    • Merchant Cash Advance: MCA is often based on the business’s daily credit card sales or overall revenue, and it may not require a thorough credit check. The primary consideration is the business’s ability to generate future sales.

Repayment Structure:

    • Factoring: The factor collects payments directly from the business’s customers. Once the customers pay the invoices, the factor releases the remaining balance to the business after deducting fees.
    • Merchant Cash Advance: Repayment is tied to the business’s daily credit card sales or fixed daily/weekly debits from its bank account. The repayment amount is a percentage of future revenue, making it more flexible but potentially more expensive.

Risk and Cost:

    • Factoring: The factor assumes the risk of non-payment by customers. The cost of factoring is typically determined by fees and discount rates applied to the total invoice value.
    • Merchant Cash Advance: The business assumes the risk, and the cost is usually expressed as a factor rate. The total repayment amount is the advance amount multiplied by the factor rate.

Use of Funds:

    • Factoring: Factoring is often used to improve cash flow and working capital, allowing businesses to meet immediate financial obligations and invest in growth opportunities.
    • Merchant Cash Advance: MCAs are commonly used for various purposes, such as inventory purchases, equipment acquisition, or covering operational expenses during slow periods.

Factoring involves selling invoices to improve cash flow, while a Merchant Cash Advance involves receiving an upfront cash advance based on future revenue.  With factoring, the work is already done therefore the risk is very low and thus the fees are lower.  With an MCA, there is nothing done and, in fact, there is typically not even an order for loan repayment so fees are much higher.  The choice between factoring and MCA depends on the specific needs and circumstances of the business, including the nature of its revenue streams and the desired use of funds. 

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