What follows comes from an interview deBanked’s Sean Murray conducted with accountants Yoel Wagschal, CPA and Christina Joy Tharp, and covers the third and fourth questions he asked them.
Clients and their accountants ask it all the time: how do we report merchant cash advances? Can we do it as a loan?
No, and never use the word “loan” when referring to a merchant cash advance. Usury laws would be broken at the rates these deals carry. Never use “loan” in any letters to the client. Never use it in web materials. Never use it in any marketing materials or publications. The way to make the sale is to explain that you are buying future receivables. Don’t you dare ever, ever call what you’re doing a loan!
How should an MCA funder book their purchase of future sales under GAAP, and how should they file their taxes with the IRS?
Follow GAAP. The IRS has no tax provisions specifically for the MCA industry. However, for taxes, you do have the option to deviate from GAAP. It’s not just you, every industry has the opportunity to write a tax return that’s not exactly the same as their financial statements.
For fun, let’s start with a basic journal entry.
A company (let’s call it Firm X) buys product XYZ for $1,000.
Account Debit Credit
Inventory/Purchases debited 1,000.
Cash credited 1,000.
XYZ was then resold for $1,500.
Account Debit Credit
Debit Cash for $1,500
credit Sales for $1,500.
As you can see, the firm’s profit equals $500. If this profit does not show up in the firm’s bank accounts, however, it is necessary to find and reconcile all of the firm’s accounts to locate where the profit has gone.
A basic double-entry accounting system can accurately model an MCA business, though a complex, automated system is necessary in practice.
For example, a supermarket may have thousands of customer orders to ring up in a single day. Writing down every item in a business’s inventory might work for a retailer that just sells a few items, but for a business with a large number of products or a high sales volume (or both), keeping tabs on each item becomes impossible.
That is why, if you run a retail business, you need a great point-of-sale system. With this technology, you can keep track of everything coming in and out of your store and still post just one summary entry in your ledger. Even if your POS doesn’t integrate with your accounting software, it can still produce paper reports that you can use to create those summary posts.
So you sold a total of $300,000 worth of product. Out of that, you received $280,000 in cash and $20,000 in credit. This will look like this in your books.
Account Debit Credit
Cash debited 280,000
A/R debited 20,000
Sales credited 300,000
It’s ok to do only one general ledger entry for everything sold in a given period.
If the POS keeps track of every little sale you make in real time, how do you reconcile your sales? You’ll have to verify that you’ve reported all of your sales by reviewing your bank statements. That’s your system’s endpoint.
If your point of sale summary, your general ledger entry and your cash and A/R equal what is in your bank account, your books are reconciled correctly. If they don’t equal what is in your bank account, you still have work to do. All three of these items must reconcile.
Applying this to MCAs, there are two big challenges they face.
One is how to find suitable management software.
Two is finding an accountant who knows how to book the numbers properly.
Remember that a retailer is selling a product for money, while an MCA firm is selling money for money. To put it another way, the MCA firm is buying future receivables. As a merchant cash advance funder, your “point of sale” is your bank account. But the reports that a bank offers are not exactly what is needed.
To do this well, an MCA must have excellent management software that tracks each and every cent. This software must keep the company’s book records consistent with the firm’s bank statements.
The only way to make it work is to have one bank account used only for the transactions that the software tracks. Paying your phone bill with this account is like grabbing a $100 bill from the register.
Once you have properly set up a dedicated account and hired an accountant who ties the ledger to the bank, then and only then you are in good shape.
MCA journal entries are confusing because there are so many small entries needed.
That is why you must hire an accountant who understands both GAAP and the MCA industry.
Take an example: a merchant cash advance provider, Firm F, starts out with a $50,000 investment. There are three investors (called syndicators).
Then, the MCA firm buys future sales from a merchant, Merchant ABC. The full value of the receivables is $100,000. Firm F buys it for $70,000. The three syndicators each fund 25%, or $17,500, of that $70,000.
Over the course of 100 days, the merchant will have paid $1,000 a day, for a total of $100,000.
The profit was $30,000. Let’s say the four investors split this $30,000 evenly four ways at $7,500 each.
In industry terms:
- Funding: 70,000.
- Payback: 100,000.
- Daily ACH: 1,000
Account Debit Credit
Operating Cash debited 50,000
Equity credited 50,000
Account Debit Credit
MCA Cash debited 70,000
Syndicator #1 credited 17,500
Syndicator #2 credited 17,500
Syndicator #3 credited 17,500
Operating Cash credited 17,500
Account Debit Credit
Accounts Receivable debited 100,000
MCA Cash credited 70,000
Revenue credited 30,000
Account Debit Credit
MCA Cash debited 1,000
Accounts Receivable credited 1,000
When a syndicator gets paid depends on the company. You can pay the syndicators in one lump sum at the end of the deal. Then you will pay each one by crediting cash and debiting the account of that syndicator for principal, and debiting revenue or an offset account for their profit share. You never owned their share.
For each and every day, the funder debits 1,000 and credits the same amount for 100 days. The net result at the end looks like this:
Account Debit Credit
Syndicator #1 debited 17,500
Syndicator #2 debited 17,500
Syndicator #3 debited 17,500
Revenue debited 22,500
Operating Cash debited 25,000
MCA Cash credited 100,000
Cash: 57,500.
Total assets: 57,500.
Equity: 57,500.
Revenue: 7,500.
As you can see, everything is equal and accounted for. It all lands where it should. The firm started with $50,000 and the firm’s 25% share earned $7,500 in revenue.
Once you understand it and have the right systems, this is easy, even if you run a million transactions a day.
As a merchant cash advance provider, your books need to be tight. Without a tight grasp of your accounting, you could lose tens or hundreds of thousands of dollars and never know. Money is to a merchant cash advance company what tomatoes are to a grocer: if no one counts them, they vanish unnoticed. Without good systems in place, you will not know where the money is, how much of it is yours, and how much of it is cash owned by others.
Every business is unique. No accountant can, or should, give advice without looking over your books. Find an accountant who is an expert in the MCA industry.
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