Calculating the Real ROI of a Merchant Cash Advance: Beyond the Numbers

Calculating the Real ROI of a Merchant Cash Advance: Beyond the Numbers

2024.04.27

Merchant cash advances (MCAs) provide a swift funding solution for small businesses, with 10% of small businesses in the US seeking financing, opting for MCAs in 2021. However, the real question is whether an MCA is the optimal choice for your business needs.

To calculate the true Return on Investment (ROI) of an MCA, one must look beyond the initial capital received. In 2021, the MCA industry saw a significant rise, with approval rates reaching 85% and the sector experiencing the highest growth among all funding types.

This blog post aims to furnish you with the insights necessary to evaluate the genuine effect of an MCA on your business and ascertain if it yields a favorable ROI. 

Understanding the Cost of MCAs

Before diving into ROI calculations, it’s crucial to understand the true cost of MCAs. Unlike traditional loans with a fixed interest rate, MCAs utilize a factor rate

This number represents the multiplier applied to the advance amount to determine the total repayment. However, the factor rate doesn’t tell the whole story. Hidden fees, such as application fees, processing fees, and daily debit authorization fees, can significantly inflate the overall cost.

According to the Federal Trade Commission (FTC), the average factor rate for an MCA can range from 1.1 to 1.5, which might seem reasonable at first glance. However, when you consider the repayment structure, the effective cost can be higher.

For example, an MCA with a factor rate of 1.2 and a 6-month repayment term translates to an effective APR (Annual Percentage Rate) of over 40%.

A Real-World Example: Bakery Uses MCA to Expand Online Presence

Let’s consider a real-world example. “Flour Power Bakery,” a local bakery from Oregon, known for its delicious treats, saw a surge in online ordering during the pandemic. They wanted to capitalize on this trend by investing in a user-friendly online ordering system and social media marketing campaigns. However, their traditional loan options were limited due to their relatively new business status.

Flour Power Bakery explored various financing options and opted for a Merchant Cash Advance due to its quick turnaround time and flexibility.  The MCA allowed them to invest in the necessary technology and marketing efforts, leading to a significant increase in online orders and overall revenue.

This directly impacted their profitability, enabling them to comfortably repay the MCA while establishing a strong online presence for long-term growth.

Calculating the Effective ROI of Your MCA

Here’s where things get interesting. While factor rates provide a basic cost estimate, a more accurate picture of your MCA’s impact comes from calculating the effective ROI. This takes into account not only the upfront cost but also the potential increase in revenue generated by using the MCA funds.

Here’s a simplified formula to estimate the effective ROI:

Effective ROI = (Increased Revenue from MCA – Total Cost of MCA) / Total Cost of MCA

An Important Note: Calculating increased revenue can be challenging and depends on how you plan to use the MCA funds. For instance, if you use the MCA to invest in marketing campaigns that attract new customers, the potential increase in revenue can be significant. 

However, accurately predicting that increase can be difficult.

Beyond the Numbers: Qualitative Factors

While the ROI calculation provides a valuable quantitative measure, there are also qualitative factors to consider:

  • Improved Cash Flow:  MCAs offer a quick cash injection, which can improve short-term cash flow and help you seize time-sensitive opportunities. In Flour Power Bakery’s case, the MCA allowed them to invest in online growth strategies without disrupting their day-to-day operations.
  • Flexibility: Repayment terms with MCAs are often based on a percentage of your daily sales, offering flexibility in fluctuating revenue periods. This can be beneficial for businesses with seasonal sales patterns.
  • Credit Score Hurdle: For businesses with less-than-perfect credit, MCAs can be a more accessible financing option compared to traditional loans with stricter credit score requirements.

Conclusion

Calculating the real ROI of your Merchant Cash Advance involves a multi-faceted approach.  While the effective ROI formula provides a starting point, consider qualitative factors like improved cash flow and flexibility.  Ultimately, the decision of whether an MCA delivers a positive ROI depends on your specific business needs and financial situation.

As a seasoned financial advisor, I’ve witnessed MCAs empower businesses to capitalize on fleeting opportunities.  For example, “Flour Power Bakery,” used an MCA to invest in a user-friendly online ordering system and social media marketing campaigns during a surge in online ordering. 

This quick cash injection allowed them to capitalize on the trend, leading to a significant increase in sales and a rapid repayment of the advance.  However, MCAs aren’t a one-size-fits-all solution.  The potentially high effective APRs make them less suitable for long-term financing needs.

If you do decide to pursue an MCA, prioritize transparency. But, before committing to an MCA, explore all financing options.  Consult a financial advisor to assess your business’s creditworthiness and explore alternatives like loans or lines of credit. 

Remember, the goal is to leverage financing to fuel your business growth, not burden it with excessive debt. 

FAQs

  1. What are some alternatives to Merchant Cash Advances?

Several financing options exist, including traditional small business loans, lines of credit, and invoice factoring. Each option has its own pros and cons in terms of interest rates, repayment terms, and qualification requirements.

  1. Can I use an online calculator to estimate the ROI of an MCA?

While online calculators can estimate the cost of an MCA based on the factor rate and repayment terms, accurately calculating the increased revenue (and therefore the ROI) can be challenging. 

These calculators can be a helpful starting point, but consult with a financial advisor for a more comprehensive analysis that considers how you plan to utilize the MCA funds.

  1. Should I get a Merchant Cash Advance if I have bad credit?

While MCAs can be more accessible for businesses with less-than-perfect credit compared to traditional loans, the factor rates tend to be higher. 

This can significantly impact the overall cost of the MCA and potentially negate the positive ROI, especially if the increased revenue isn’t substantial. Explore all financing options and weigh the pros and cons carefully. 

Consider consulting with a credit repair specialist to improve your credit score, which can open doors to more favorable loan options in the future.

  1. How can I improve the ROI of my Merchant Cash Advance?

Here are some key strategies to improve the ROI of your MCA:

  • Strategic Investment: Use the MCA funds for investments with a clear ROI in mind. For example, invest in marketing campaigns proven to generate new customers or inventory purchases that directly increase sales.
  • Cost Reduction Strategies: Consider using the MCA to invest in equipment or technology upgrades that lead to long-term cost savings. This can offset the upfront cost of the MCA and improve your overall profitability.
  • Repayment Efficiency: Explore options for early repayment if your cash flow allows. This can help reduce the total interest or fees associated with the MCA.
  1. Is there a difference between daily and fixed-term repayments for MCAs?

Yes, there are two primary repayment structures for MCAs:

  • Daily Debit Authorization: This method allows the lender to withdraw a percentage of your daily sales to repay the advance. This offers flexibility but can impact your cash flow during periods of low sales.

Fixed-Term Repayments: With this structure, you agree to a set repayment schedule with fixed monthly payments. This provides predictability but requires stricter adherence to the schedule, even during slow sales periods.

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