Merchant Cash Advance in the Retail Sector

The retail sector has some unique financial needs. There are various types of retail establishment across the world which use different types of arrangements to fund their day-to-day capital needs. The larger and more sophisticated retail chains have access to formal loans from banks. However, this may not be the case for small and medium businesses.

Retail companies which fall in this sector do not have access to the same financial products as their multinational counterparts. It is for this reason that there are some specialized financial products which are used by such companies.

Merchant cash advance is one such financial product which is extensively used by small and medium retail businesses. In this article, we will have a closer look at what merchant cash advance is as well as how it really works.

What is Merchant Cash Advance?

A merchant cash advance is a financing option for businesses that either do not qualify for a traditional bank loan or do not have the assets required to provide as collateral in order to avail such loans.

A merchant cash advance is a short-term loan with a flexible repayment schedule which is provided by the lender based on the credit card receipts that the retail business generates within a given period of time. Since a large portion of retail sales are made up of credit card transactions, they have a consistent flow of such transactions which are then used by the financier as collateral in order to provide the advance.

The repayment of these loans is not manually made by the borrower i.e. the retail company. Instead, the repayment of these loans is automatically deducted from the credit card receipts which accrue to the retail company when they sell their products. This means that when retail companies sell their products and accept credit card as a mode of payment, a certain percentage of this payment is held back by the merchant as repayment of the loan.

The average credit card receipts which accrue to the borrower are extremely important for this model to function. It is for this reason that merchant cash advance is only provided to retail companies which have consistently demonstrated the ability to generate credit card sales.

The size of merchant cash advance which is provided by the lender varies across geographies. In some parts of the world, lenders provide no more than 50% of the monthly credit card receipts as merchant cash advance. However, in other parts of the world, lenders do not mind giving out even 250% of the average monthly credit card receipts as a loan. The higher the loan amount sanctioned by the lender, the longer it will take for them to recover such amount. Also, higher amounts generally mean higher risk for the lender as well as the borrower.

How Does Merchant Cash Advance Work?

The typical merchant cash advance agreement which is structured between a business owner and a lender has the following terms and conditions:

1. Advance Amount: This amount refers to the amount of borrowing which has actually taken place. This is the amount which the lender provides to the borrowing retail company as a part of the merchant cash advance agreement. This amount is based on several parameters which include the overall financial strength of the firm as well as the average credit card receivables which accrue to the firm every month.

2. Payback Amount: The payback amount is the amount of money which the borrower has to repay in order to close the merchant cash advance. Hence, the payback amount includes the advance amount, accrued interest as well a processing fee.

   It needs to be understood that the payback amount is a dynamic figure which varies based on the payback period. This is because the repayments made in a merchant cash advance are not fixed. Instead, the repayments can vary based on numerous factors such as daily sales of the borrower and the number of days required to repay the loan.

3. Holdback: Merchant cash advance is not paid back via fixed instalments. Instead, such an advance is paid back via a percentage of the credit card receipts which are held by the merchant.

   For example, if the holdback percentage agreed upon in the contract is 50%, and if the daily credit card sales of the retail company are $1000, then the lender can withhold $500 i.e. 50% of $1000 and pay only the balance to the retail company.

   The rate at which credit card sales will be used to repay the cash advance is called the holdback rate or the retrieval rate. It is common for the holdback rate to be between 5% and 20% of the daily credit card sales.

Many retail businesses prefer taking out merchant cash advances since the repayment of such loans is associated with their sales.

If the sales are high in a particular month, a higher amount is allocated towards the repayment of the loan. On the other hand, if the sales are low in a particular month, the amount being allocated towards repayment reduces and the overall tenure of the loan. In either case, when the cash flow of the firm increases or decreases, it is less likely to default on such cash advances.

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