Invoice Factoring vs. Merchant Cash Advance: 9 Reasons to Choose Factoring for Your Business

Posted on 20.January.2023 by Mike Winters | @amcomcap

Small Business Owner Working in the Office

Image: wichayada69 / Envato Elements

Invoice factoring and merchant cash advances are both forms of alternative funding for businesses, but they work very differently. As a business owner, you should know the in’s and out’s before jumping into any arrangement with a third-party invoice factor or merchant cash advance company, including the terms specific to the company you’re considering working with. For this post, however, we’re considering how these two forms of funding work on a basic level in most cases, as specific terms may vary.

For those who don’t know, invoice factoring, also known as accounts receivable financing, is a financial transaction in which a business sells its outstanding invoices to a third party at a discount to receive immediate cash. This type of financing is often used by businesses that have a large number of outstanding invoices and need cash quickly to cover expenses or invest in growth. On the other hand, a merchant cash advance (MCA) is a lump-sum payment that a business receives in exchange for a percentage of its future sales. This type of financing is typically used by businesses that have a high volume of credit card sales and need cash to cover short-term expenses such as inventory or equipment purchases.

Here are five reasons why a business might choose invoice factoring over a merchant cash advance:

  1. Invoice factoring provides immediate cash. Invoice factoring allows businesses to receive cash quickly, without having to wait for customers to pay their invoices. This can be especially helpful for businesses that have a lot of outstanding invoices and need cash to cover expenses or invest in growth. Meanwhile, a merchant cash advance is a lump-sum payment and the business might have to wait longer to receive the funds.
  2. Invoice factoring offers more flexible financing. Invoice factoring is a flexible form of financing, as businesses can choose to factor only certain invoices or all invoices, and can also choose to factor invoices on a one-time or ongoing basis. This flexibility allows businesses to tailor their financing to their specific needs. Merchant cash advances, however, typically require a fixed repayment schedule, which may not be as flexible.
  3. Invoice factoring provides credit and collection management services. Invoice factoring also typically provides credit and collection management services, which can be a valuable resource for small and medium-sized businesses with limited resources. The factoring company will take on the responsibility of collecting payment from customers, freeing up the business owner’s time to focus on other aspects of the business, such as sales, marketing, and production.
  4. Invoice factoring can help businesses to retain positive customer relationships. If the factoring company takes on the responsibility of collecting payments, the business can maintain a more cordial relationship with its customers. Now that the business does not have to pester customers to pay their invoices, the relationship can blossom without the added friction this may cause. This can be important for businesses that want to maintain good, strong relationships with their customers free of any payment-related stresses.
  5. Invoice factoring can be more predictable. With invoice factoring, businesses receive cash immediately and the factor is responsible for collecting payment from the customers. This means that businesses can predict their cash flow more accurately. With a merchant cash advance, businesses receive a lump sum of cash, but the repayment schedule is based on a percentage of future credit card sales, which can be less predictable.
  6. Invoice factoring can be more cost-effective and less risky. Invoice factoring is often more cost-effective than a merchant cash advance, especially for businesses with a steady stream of invoices. Factors typically charge a small fee, called a factor rate, to purchase invoices. This rate is usually a small percentage of the invoice amount. Merchant cash advances often have higher costs and shorter repayment terms, which can make them more expensive in the long run. As NerdWallet says, merchant cash advances “can carry annual percentage rates in the triple digits and create a difficult cycle of debt.”
  7. Invoice factoring can help businesses that have a hard time getting traditional financing. Invoice factoring can be a good option for businesses that have a hard time getting traditional financing, such as small businesses or start-ups. The factoring company will evaluate the creditworthiness of the business’s customers, rather than the business itself, which can make it easier for the business to get financing. Many merchant cash advance services, however, have a minimum credit score you must meet as part of the approval process.
  8. Invoice factoring can help businesses with seasonal cash flow. Invoice factoring can help businesses with seasonal cash flow, such as those in retail or construction, by providing a steady stream of cash throughout the year. A merchant cash advance may not be able to provide the same level of support for a business with fluctuating cash flow needs.
  9. Invoice factoring can be used for specific purposes. Invoice factoring can be used for specific purposes, such as to pay for inventory, to cover payroll, or to expand the business. A merchant cash advance may not be as flexible in this regard.

Every business financing option has its own set of pros and cons, and the best choice will depend on the business’s specific needs and financial situation. A business should weigh the advantages and disadvantages of both invoice factoring and merchant cash advances, and consult with a financial expert before making a decision.

Invoice factoring can provide a business with immediate cash, provide credit and collection management services, support growth and expansion, provide flexibility, and help a business maintain positive customer relationships. On the other hand, merchant cash advances can provide a business with a lump-sum payment but typically have extremely high APRs and a rigid fixed repayment schedule that could impede your cash flow and turn into a vicious debt cycle. Choose wisely.

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Roy Brooks and American Commercial Capital, LLC, has provided invoice-factoring services to Houston-area small businesses since 2003. We work with businesses in San Antonio, Dallas, Austin, Fort Worth, Beaumont, Port Arthur, Corpus Christi, and other nearby Texas cities.

If you want to learn more about how cashflow-sensitive invoice factoring can help your business, give us a call at 713-227-3863, contact us here, or fill out our form for a free, no-obligation quote.

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