We helped family-run Lancashire business Minerva Crafts get the funding they needed to expand their warehouse

Knowledge>Working capital finance>Business cash advances

Business cash advances

A business cash advance is a type of lending based on future revenue. It comes in a few different forms, the most common of which is a merchant cash advance, and might also be known as a revenue loan, a turnover loan, or revenue-based financing.

A cash advance is different to a business loan, because instead of having an outstanding loan amount, interest rate, and term, a cash advance effectively sells future sales to the lender at a discount.

This means the terminology used is a little bit different, for example ‘advance rate’ instead of ‘loan amount’, and the two types of lending will feel a bit different for the business. Let’s have a look at business cash advances and see how they work.

How does a business cash advance work?

With a standard business loan, you get a lump sum at the start of the term, and then pay interest for as long as that amount is owed. This concept applies to loans, overdrafts, revolving credit facilities, and lots of other types of finance — in fact, most of the common forms of finance work on this principle.

With a loan, the total cost of the finance — i.e. the interest you pay on top of the principal lump sum — varies depending on how long you take to pay back the loan. Business cash advances turn this idea on its head. Instead of having interest constantly ‘running’, the total cost of finance is agreed up-front. So instead of a monthly interest calculation, there’s a fixed finished line you need to get to. Here’s how it works in detail:

Business cash advance example

  • Advance amount: £10,000
  • Amount repayable: £12,500
  • Monthly repayment percentage: 20%

In this example, the lender offers to buy £12,500 worth of future sales for £10,000, at a repayment percentage of 20%. So £10,000 is what you get now, and £12,500 is what you’ll eventually pay back.

You might look at these figures and think “I’ll be paying 20% interest”, but that’s not the case. With a business cash advance, repayments are taken from your revenue — so the 20% figure doesn’t refer to interest, but rather the proportion of your revenue that will go towards paying back £12,500. Let’s see how this breaks down per transaction:

  • Customer 1 pays £10; you keep 80% (£8) and the lender gets 20% (£2)
  • Customer 2 pays £129.99; you keep 80% (£103.99) and the lender gets 20% (£26)
  • Customer 3 pays £450.96; you keep 80% (£360.77) and the lender gets 20% (£90.19)

After these three transactions, you’ve made repayments of £118.19 (2+26+90.19). Of course, you’ll have more than three transactions in an average day — this is just a simple way to demonstrate how it works. The key point is that each of these transactions chips away at the £12,500 repayment amount — the finish line.

The crucial thing to understand about this method of repayment is that because it’s proportional, you pay back more when your revenue is higher and less when things are slow. But however it turns out, the total cost of finance doesn’t change — you’ll always be paying down £12,500, and there’s no compounding interest.

This method of repayment means that cash advances are more flexible than business loans, because instead of a fixed monthly repayment that has to be met regardless of your sales, the amount you repay goes up and down each month in line with your sales.

Merchant cash advances

Merchant cash advances are by far the most common form of business cash advance, because the payments technology makes it very straightforward to track. They’re designed specifically for merchants — in other words, businesses that take payment using a card machine — and the lender works with your payments provider to be directly involved with each transaction.

The advance amount is usually based on your average month’s turnover, so the lender will want to see your last few months of card sales. As with the example above, you’ll have an advance amount and an agreed repayment percentage.

The main advantage of merchant cash advances specifically is that once they’re set up, they require very little oversight. There’s no monthly repayment to worry about, because every single transaction pays down the debt, and you’ll know the total cost from the beginning.

Business owners often find that the repayments feel painless too, because rather than putting money aside you just carry on as normal, and the advance is automatically repaid. Most merchant cash advance providers offer an online login where you can see the status of your advance, and many will offer top-ups once a certain portion has been repaid.

Invoice finance

Although it’s not technically a type of business cash advance, invoice finance is worth mentioning here, because like these other products it works by selling something to the lender at a discount — namely, accounts receivable in the form of unpaid invoices. In fact, this is where ‘invoice discounting’ gets its name. Read our invoice discounting page for an example of how the pricing works.

The key point about invoice finance is that if your customers owe you money, you can get most of the value of these invoices from the lender within a day or two, and then the remainder minus fees once your customer has paid. If your business operates in an industry with long payment terms like recruitment or construction, invoice finance is a useful way of smoothing out cashflow bumps and making things a bit more predictable.

Overdraft alternatives

If you’re looking into business cash advances because of flexibility, it’s also worth considering overdrafts, business credit cards and their alternatives like revolving credit facilities. All of these products give you a pre-approved credit limit that you can use as and when you need — so they’re a useful safety net to have in place.

One downside compared to business cash advances is that the amount you can borrow might be lower, and the cost varies depending on your usage.

Share this article