Cash is king. There’s a reason that’s a saying. Most businesses that are profitable still have cash problems.
A business that’s generating revenue and coming out each month with a profit can be easily deceived to thinking they are doing alright. But what’s lurking behind the scenes is a problem that most businesses struggle with, and that’s cash flow.
Importance of Cash Flow
Most businesses go out of business, not because they aren’t profitable or they aren’t making sales, it’s because they run out of cash. That’s why cash management is one of the most important functions an owner must focus on diligently.
In addition, not having cash on hand prevents them from pursuing and investing in opportunities that come up.
For example, let’s say you’re a growing eCommerce company and you’re hitting up against 80% capacity in your warehouse. It’s manageable and you still have a little room to grow.
But you know that eventually, if you want to continue the rapid growth, you are going to need more warehouse space. It’s not urgent, but critical to growth.
Let’s say a distributor down the street is going bankrupt and they are liquidating their warehouse that is three times the size of your current location at a super low price. In fact, its about half of the per square footing price of the warehouse you have now. That’s a great deal!
If you had the cash on hand, you could take advantage of this deal and you could do it quickly. But without the cash, you’d have to raise the funds and by the time you got the money together, another buyer swooped in and took the deal.
For examples like that above, having access to cash can be critical to the future growth of your business. Getting cash quick for opportunities like this can be difficult but not impossible.
Merchant Cash Advance
There are financing companies out there that offer what’s called a merchant cash advance. It’s technically not a loan. It’s simply a cash advance.
The cool part of this is that the financing company will be repaid via portions of your credit card transactions. That means the repayments are automatic, but they also fluctuate with your sales which makes it ebb and flow with your current cash flow.
It works like this. A financing company will give a merchant say $10,000. In return, the merchant will repay the financing company $14,000. That’s a factor of 1.4 (10,000 X 1.4 = 14,000).
Then the financing company will hook up with the merchants credit card services and automatically withhold say 10-20% of each transaction until the $14,000 is repaid in full.
Advantages of Merchant Cash Advance
Of course the main advantage is that the merchant gets cash up front. They can use it to invest in new equipment, a new warehouse or pay off another creditor.
They can also use it to make payroll in a cash crunch or even to make improvements on their facilities. Many retailers use it when they don’t have cash on hand or the credit to be able to buy bulk wholesale inventory.
The other advantage is that it gets automatically paid back, so there’s less of a temptation to not pay it. Also, because it tracks with your sales, you repay it as you generate cash.
Another benefit is that its quick cash. Applying for a loan at your local bank could take months and a ton of paperwork. By then, you’re out of business or you’ve missed the great investment opportunity.
Disadvantages of Merchant Cash Advance
The downside is that the merchant may get addicted to this type of financing. You are looking at a 30-40% interest rate with this method. That’s higher than a credit card although you may end up paying less interest and fees than you would a typical credit card that you have a harder time paying off.
The other potential risk is that this industry is not regulated because it is technically not a loan. There have been court cases that ruled this is not a loan and therefore the regulations around that do not apply.
You would just need to make sure you are working with a reputable company.
Other Repayment Method
Although hooking up with a credit card machine is usually preferred, there are other ways to pay back the cash advance.
One way is for the total credit card sales amount to be deposited into a bank account that the financing company owns and controls. Then they take out their portion of the payments.
The other ways is via ACH withholding. You allow your credit card sales transaction information to be shared with the financing company. Then based on that information, the financing company will wire out their portion from your bank account.