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Updated: Feb 5, 2020
For many small businesses, the number of loan opportunities available can be overwhelming, especially if the business owner isn’t familiar with the options, advantages, disadvantages and terms of each type of loan. For businesses that don’t qualify for intermediate or long-term financing or that have cash flow issues, it’s important to understand the ins and outs of shorter-term loan options. Although these alternatives to traditional financing usually have much higher interest rates than longer-term financing solutions, they can nevertheless help the business if used in the right context.
There are several types of short-term loans, including credit card receivables financing; invoice factoring; accounts receivable financing; and business lines of credit. This article focuses on one type of short-term loan in detail: credit card receivables financing.
Also called a merchant cash advance, credit card receivables financing occurs when financiers purchase a percentage of a business’ future credit card sales at a discounted rate. The financier advances a lump sum to the business, which is then paid back by extracting a set percentage from debit and credit card sales on a daily basis. These payments are made automatically via the business’ credit card processor until the loan and its fees are repaid.
For example, a business may need to borrow $10,000 to help with their marketing costs. They can use credit card receivables financing to receive the $10,000 up front, and agree to repay that lump sum plus a fee ($1000 to $5000, depending on the factor rate) via a percentage of their daily debit and credit card sales until the total amount has been repaid.
Merchant cash advances are typically awarded in amounts ranging from $5,000 to $500,000. They are repaid in periods as short as one week to as long as two to three years, depending on the loan amount and the business’ sales volume.
Credit card receivables financing is a viable option for newer businesses that don’t have a long-term credit history, or companies with cash flow problems or low credit scores. However, compared to term loans, their rates are much higher – with a factor rate of 1.1 to 1.5, their APR rates can be as high as triple digit numbers depending on daily sales revenue.
Credit card receivables factoring is a viable option for businesses that can show daily credit card sales, such as retail establishments and restaurants. As long as the business can show debit and credit card transaction volume, they will likely qualify for the advance and receive the lump sum within one to two days. The advance will not impact business credit or negatively affect cash flow; since it’s based on the total credit card sales in any given day, there is no minimum amount due, nor is there a set loan term. These can be advantageous for businesses that experience periods of reduced sales or seasonal fluctuations.
With all financing, it is important to match the loan type with the projected return timeline. Although credit card receivables financing is a practical albeit expensive option for covering short-term cash flow problems, it is not considered a viable option for funding long-term growth, such as purchasing equipment, space, or hiring new employees. Instead, these advances are best used for marketing, or to purchase inventory or supplies.
As with other short-term loan options, credit card receivables financing can help a business through a financial slump and assist them in building their revenue and credit history, with the goal of eventually experiencing higher profits and a more stable financial status. Sustained financial stability can then open the door to more affordable financing for long-term growth.
Michael Jones is a Senior Editor for Funding Circle, specializing in small business loans. He holds a degree in International Business and Economics from Boston University's Questrom School of Business. Prior to Funding Circle, Michael was the Head of Content for Bond Street, a venture-backed FinTech company specializing in small business loans. He has written extensively about small business loans, entrepreneurship, and marketing.