How to calculate the cost of a merchant cash advance

The four lines

Illustrative only — an advance of $35,000 at a factor rate of 1.32, with a 2.5% origination fee deducted at funding, repaid by daily debits over five months.

1. Total repayment. $35,000 x 1.32 = $46,200.
2. Cash received. $35,000 − $875 = $34,125.
3. Cost. $46,200 − $34,125 = $12,075.
4. The debit. Five months at 21 banking days is 105 debits: $46,200 / 105 = $440.00 a day, or $2,200 a week.

The cost against the amount funded is $11,200. The cost against the money you actually got is $12,075. The second figure is the true one, and the effective factor on cash received is 46,200 / 34,125 = 1.3538.

Converting it to a rate

Only after the term is fixed. Treat the debits as a level annuity, solve for the daily rate that makes 105 payments of $440.00 worth $34,125 today, and multiply by 252 banking days. That gives an annualised 152.4%.

Change the term and that number moves a long way while the $12,075 does not move at all. If your contract remits a percentage of deposits rather than a fixed amount, the term is a forecast, so run the calculation at two or three plausible terms and quote the range.

What the four lines miss

The same four lines when the remittance is a percentage

If the contract takes a share of deposits instead of a fixed daily amount, line 4 becomes a forecast and the annualised figure moves with it. Run it twice.

Illustrative only — the same $46,200 to deliver and the same $34,125 received, remitted at 12% of daily deposits.

• Deposits averaging $3,400 a business day: the debit is $408, it takes 113 debits, about 5.4 months. Annualised, 140.7%.
• Deposits averaging $2,900 a business day: the debit is $348, it takes 133 debits, about 6.3 months. Annualised, 119.0%.

The cost is $12,075 in both. Quote the pair rather than the midpoint, and use your own trailing twelve months of deposits rather than the funder's assumption. If the two figures are far apart, the honest description of the deal is a range, and any single rate you are shown is a forecast wearing a decimal point.

Putting it next to a loan

The comparison people want is against a bank product, and it only works if both sides are computed the same way: every dollar that leaves, against the cash that arrived.

Illustrative only — $35,000 as a twelve-month amortising loan at a 24% nominal rate. The payment is $3,309.59, the total is $39,715.03, the interest is $4,715.03, and if there were no fee you received the full $35,000. Against the advance above, the same $35,000 of face amount costs $12,075 over about five months.

Two different obligations, and the difference is not two percentage points. It is roughly two and a half times the dollars, over less than half the time. A comparison that puts "1.32" next to "24%" and concludes the first is cheaper has compared a multiple with a rate, which is not a comparison at all.

Where line 2 goes wrong

The cash-received line is the one funders describe least precisely, and there is usually more than one deduction in it. Ask for each of these in dollars before funding:

• Origination fee or points, and whether the percentage is applied to the advance or to the purchased amount.
• Packaging, documentation, underwriting or administration fees, which frequently appear under more than one name.
• A UCC filing fee, and a wire or same-day funding fee.
• Any first remittance taken at funding rather than on the first business day after.
• Any amount withheld to pay off an existing position, which is money you never see and should never count as cash received.

Add them up, subtract from the advance, and put the result in line 2. Everything downstream depends on that one number being right.

The check worth doing before any of this

Divide the weekly figure by the free cash your business generates in a week. Not revenue — cash after cost of sales, fixed costs and existing debt service. If $2,200 a week is more than that number, the arithmetic above is describing a deal the business cannot complete, and the cost calculation is beside the point.

Illustrative only — suppose the business does $46,000 a month of revenue at a 40% gross margin, so $18,400 of gross profit, against fixed costs of $12,500 a month. That leaves $5,900 a month, or about $1,360 a week, before any owner's draw and before any existing debt service.

The remittance is $2,200. The gap is roughly $840 a week, and the business funds it by not paying something else — a supplier, a tax deposit, the owner. Five months of that is the mechanism by which a second advance gets taken, and it is visible in this arithmetic before you sign rather than in the statements afterwards.

Run it on your own last thirteen weeks, and run it on the worst four of them rather than the average.

The calculators will do the conversion once you have the four lines. Get the fee list in dollars first, because line 2 is the one funders describe least precisely and it changes the answer more than the factor does.