Background

Short-term merchant financing (commonly called merchant cash advances or MCAs) gives fast capital in exchange for a portion of future sales or a fixed short-term payoff. Retailers use it for inventory, seasonal staffing, or emergency repairs when bank credit is unavailable. The trade-off: convenience for cost — these products often use factor rates and holdback percentages rather than traditional interest, which can translate to very high effective APRs and unpredictable repayment timing (Consumer Financial Protection Bureau).

How it works — key terms

  • Advance or principal: the lump-sum amount the lender gives you.
  • Factor rate: a multiplier (for example, 1.25) applied to the advance to calculate total repayment. A $50,000 advance with a 1.4 factor rate repays $70,000 (50,000 × 1.4).
  • Holdback (remittance) percentage: percent of daily/weekly credit-card receipts withheld to repay the advance.
  • Term: not always fixed; repayment length depends on sales volume and holdback timing.

Step-by-step: calculate the true cost (practical method)

  1. Find total repayment: Advance × Factor Rate = Total Repayment.
  • Example: $50,000 × 1.4 = $70,000 total repay.
  1. Compute finance charge: Total Repayment − Advance.
  • Example: $70,000 − $50,000 = $20,000 finance charge.
  1. Estimate days to repay (use contract or historical sales). If sales vary, run a conservative scenario.
  • Example: contract expects 6 months (≈180 days).
  1. Approximate annualized cost (simple APR proxy):
  • APR ≈ (Finance Charge / Advance) × (365 / Days to Repay).
  • Example: (20,000/50,000) × (365/180) ≈ 0.4 × 2.028 ≈ 81% APR.

Note: This simple formula gives a useful apples-to-apples comparison to other loan offers. Exact APR calculations for MCA-style products are more complex because remittances usually reduce principal over time; for lender-disclosed APRs see the Consumer Financial Protection Bureau guidance and use lender amortization schedules to compute precise APRs.

Cash-flow impact metric

Calculate average daily remittance and compare to average daily sales:

  • Daily remittance = Average daily sales × Holdback %.
  • Monthly impact = Daily remittance × days per month.
    This shows how much operating cash is diverted to repayments and whether payroll or suppliers will be affected.

Example cash-flow check

If average daily sales = $2,000 and holdback = 10%:

  • Daily remittance = $200; monthly ≈ $6,000.
    If the business normally runs $10,000/month in operating expenses with $8,000 in cash on hand, a $6,000 monthly outflow materially tightens liquidity.

Common traps to watch for

  • Factor-rate confusion: lenders often advertise a factor rate instead of APR. Convert to an annualized rate for comparison. (See our deep dive on factor rates: “Understanding Factor Rates on Merchant Cash Advances”.)
  • Variable repayment timing: lower sales extend the term and reduce the APR calculation accuracy.
  • Hidden fees and reserves: origination fees, ACH or processing fees, or daily minimums increase costs.
  • Personal guarantees, bank-account control or ACH blocks that can freeze funds.

Practical evaluation checklist

  • Total repayment amount and factor rate.
  • Estimated days to repay (best, expected, worst cases).
  • Holdback percentage and expected daily remittance.
  • All fees (origination, late fees, prepayment penalties).
  • Contract clauses: personal guarantee, collateral, ACH/lockbox.
  • Tax treatment: interest and fees may be deductible as business expenses—consult IRS Publication 535 or your tax advisor.

Alternatives to consider

  • Business line of credit or bank term loan (often lower APRs but slower approval).
  • SBA microloans or small-business programs (SBA.gov for programs and eligibility).
  • Invoice financing or factoring if receivables are the constraint.

In my practice, I’ve seen retailers reduce financing cost materially by preparing a 90-day cash-flow forecast, then comparing the forecasted cash shortfall to multiple offers using the APR proxy above. Often a small delay to secure a line of credit or a short-term supplier payment plan cuts the true cost by half.

Where to learn more (authoritative resources)

Related FinHelp guides

Professional disclaimer

This article is educational and not personalized financial or tax advice. For decisions about financing, consult a qualified financial advisor or tax professional who can review your business financials and contracts.

Sources: Consumer Financial Protection Bureau; U.S. Small Business Administration; IRS Publication 535; Investopedia.