Understanding the Underwriting Methodology in Merchant Cash Advances

Welcome to our guide where we dive into the intricacies of the underwriting process for merchant cash advances (MCAs). Unlike traditional lending practices, MCAs have a unique and revenue-focused approach to assessing risk. This article will break down the key components of MCA underwriting to help you understand how these financial solutions are evaluated and structured.

The Importance of Revenue-Based Assessment in MCAs

The most crucial aspect of MCA underwriting is the revenue-based assessment. This method centers around the daily sales data and cash flow stability of your business.

Daily Sales Data and Average Daily Deposits

Lenders rely on detailed daily sales data to gauge your business’s current and future cash flow. This data can be accessed through bank statements or point-of-sale (POS) systems. By analyzing the average daily deposits, lenders can determine your business’s ability to repay the advance. For instance, a high average daily deposit indicates a more stable and consistent cash flow, making your business a better candidate for an MCA.

Evaluating Creditworthiness in MCAs

While traditional lenders place significant emphasis on credit scores, MCA lenders take a more lenient approach. However, they still consider personal and business credit scores as part of their evaluation. Additionally, they review your credit history to identify any red flags such as past bankruptcies or defaults. These factors, while not as critical as in traditional lending, still play a role in the decision-making process.

Assessing Business Type and Industry Risk

The type of business and its industry significantly influence underwriting decisions. High-risk industries face stricter scrutiny and higher fees. Lenders also assess the business model, including profit margins and revenue consistency, to gauge the risk involved. A solid business model with stable profit margins is more likely to secure favorable terms.

Evaluating Repayment Structure

The repayment structure in MCAs involves several key components, including holdback percentages and factor rates. These elements are crucial in determining the total repayment amount and the overall cost of borrowing.

Holdback Percentage and Factor Rate

The holdback percentage is the portion of daily credit card sales that will be withheld to repay the advance. This percentage typically ranges from 5% to 20%. The factor rate, which is the total repayment amount, is calculated based on the perceived risk of the advance. This rate can range from 1.1 to 1.5 or even higher. The higher the risk, the higher the factor rate, reflecting the increased cost for the lender.

Cash Flow Analysis

Another critical aspect of the underwriting process is the cash flow analysis. Lenders evaluate historical cash flow and may request future projections to assess your business’s ability to manage its finances and repay the advance. Understanding seasonal trends in sales is also essential for anticipating fluctuations in cash flow.

Documentation Requirements

While MCAs typically require less documentation than traditional loans, there are still important documents that need to be provided. Common requirements include:

Business bank statements, usually covering 3-6 months Merchant processing statements if applicable Personal identification and business registration documents

By gathering and submitting the necessary documentation, you can streamline the application process and increase your chances of approval.

Conclusion: The underwriting methodology for merchant cash advances is primarily focused on cash flow and sales performance rather than traditional credit metrics. This approach allows MCA lenders to offer financing to businesses that may not qualify for conventional loans, albeit at a higher cost due to the increased risk involved.

For more information and to learn how you can secure a merchant cash advance, visit our website or contact our team for a consultation.