Why a merchant cash advance has no APR of its own

The structural reason

An advance is not a loan with a schedule. It is the purchase of a fixed dollar amount of future receivables, collected as a percentage of what arrives. Nothing accrues, so there is no balance for a rate to act on, and there is no maturity date for a rate to be measured against.

The total is fixed on day one. How long it takes is up to your sales.

What that does to the arithmetic

Illustrative only — $30,000 advanced at a 1.35 factor. The purchased amount is $40,500 in every case below.

• Collected in 5 months, at $8,100 a month: annualised 131.0%.
• Collected in 9 months, at $4,500 a month: annualised 77.6%.
• Collected in 14 months, at $2,892.86 a month: annualised 51.4%.

Each figure comes from solving for the monthly rate that makes those payments worth $30,000 today and multiplying by twelve. The dollar cost is $10,500 throughout. Only the speed changes, and the speed is not in the contract.

Note the direction. Strong sales finish the advance sooner and produce a higher annualised cost. Weak sales stretch it out and produce a lower one. An annualised rate on this product moves inversely to how well the business is doing, which is one reason it is a poor summary of the deal.

So what do the disclosure laws require

Where a state commercial financing disclosure law applies, it generally requires an estimated APR built from an estimated term, itself built from projected sales. New York's Commercial Finance Disclosure Law under NY Financial Services Law article 8 and California's rules under SB 1235 and the DFPI regulations both take that approach for sales-based financing. Check the current text and whether your transaction is covered — coverage depends on the transaction, the provider and the state.

An estimated APR is genuinely useful. It is also an estimate, and it should be read next to the assumption that produced it.

The clauses that put a term back in

Two provisions quietly restore the maturity the product is supposed not to have, and if either is present the arithmetic above changes character.

If the contract has either, ask for the resulting figure and treat it as the floor on your annualised cost. If it has neither, the deal really is open-ended, and the thing to manage is the remittance percentage rather than the rate.

How an estimated APR is built, and how to check it

The chain is short: projected sales, times the remittance percentage, gives a projected payment; the purchased amount divided by that payment gives an estimated term; the term and the payments give a rate. Every figure downstream depends on the first one.

So ask what sales figure was used and over what period. Then check it against your own deposits for the last twelve months, including the slow ones.

Illustrative only, on the same $30,000 at 1.35. If the funder projects a twelve-month collection, the estimated annualised cost is about 59.4%. If your trailing deposits actually imply eight months, the figure is about 86.4%. Nobody has done anything wrong, the disclosure is accurate on its own assumption, and the number you were shown is twenty-seven points away from the number your business will experience.

A projection above your trailing average understates the rate. A projection below it overstates the rate and understates how long the debit will sit on your account. Both are worth catching before signature, and the question takes one line of an email.

The comparison that does work

Against another advance: cost per dollar of cash received, plus the remittance as a share of your free cash flow. Both offers are the same shape, so the ranking is stable regardless of term.

Against a loan: total dollars leaving the business, against cash received, over the same horizon. If the advance finishes in six months and the loan runs three years, compare the first six months of each and then say what happens next, rather than compressing the difference into a single rate that neither product has.

The term you can partly control

On a fixed-debit contract with a reconciliation clause, the collection period is not purely a function of sales. It is a function of sales and of whether you exercise the clause. A business that files for reconciliation in every slow month pays less each week and finishes later. One that never files pays the full debit through the slow months and finishes sooner, at a higher annualised cost, having carried the whole downturn itself.

That makes the reconciliation procedure part of the pricing. Ask what evidence is required, how many days the funder has to respond, whether the adjustment is backdated, and whether there is a fee for asking. Then put a reminder in the calendar for the first month the debit exceeds the contractual percentage, because nobody at the funder will raise it for you.

What to use instead

• The total repayment in dollars.
• The cash that reached your account after fees.
• The difference between them, which is the cost.
• The remittance amount and frequency.
• The remittance as a share of your free cash flow, in your worst month.

Those five are facts. If you also want a rate for comparison against a loan, compute it at two terms — the funder's estimate and a slower one — and quote the pair. See how to annualise a factor rate and the calculators.