Merchant cash advance vs invoice finance

Look at how your money arrives. A cafe, salon, convenience store or restaurant takes payment at the point of sale, in small amounts, by card, every day. There are no invoices to finance. A design agency, wholesaler, recruiter or engineering firm raises invoices and waits, often thirty to ninety days. There are almost no card takings to advance against.

Because the funding follows the revenue, the choice is usually made for you by the shape of your business rather than by a comparison of rates. Where the comparison genuinely matters is for the businesses that do both, and for those weighing whether to restructure how they take payment in order to reach cheaper funding.

A funder advances a lump sum, typically between 5,000 and 500,000 pounds and often anchored to about one month of card turnover. The cost is set by a factor rate, typically 1.1 to 1.5, applied once at the outset to fix the total repayable. Repayment happens automatically through a holdback, typically 5% to 20% of each day's card settlements, until the total has been delivered. Most advances are structured to clear in roughly 4 to 18 months.

The defining features are that the cost never changes and the term is an estimate rather than an obligation. If takings fall, the remittance falls and the advance simply takes longer. If takings surge, you pay the same money for less use of it, which raises the annualised cost rather than lowering it.

An invoice finance provider advances a percentage of the face value of invoices you have raised, typically 70% to 90%, usually within a day or two of the invoice being issued. When your customer pays, you receive the balance less the provider's charges. The facility revolves: as you raise new invoices, new funding becomes available.

There are two main forms. Under invoice factoring the provider also runs your sales ledger and collects from your customers, so the arrangement is visible to them. Under invoice discounting you keep control of collections and the facility can usually be confidential, so customers need never know. Discounting generally requires a larger turnover and stronger financial controls, since the provider is relying on you to collect money it has already advanced.

Pricing has two components rather than one: a service fee, typically a small percentage of the invoices financed or of turnover, and a discount charge that works like interest on the funds drawn, usually quoted as a margin over a reference rate. Because the discount charge runs while the invoice is outstanding, the cost genuinely does depend on how quickly your customers pay.

Invoice finance is normally the cheaper money, sometimes by a wide margin. The reason is not generosity: it is security. An invoice finance provider is advancing against a debt that already exists, owed by a business it has credit checked, and it holds that receivable. A merchant cash advance funder is buying sales that have not happened yet, from customers nobody has assessed, on the strength of a trading pattern. The second is a much riskier proposition and it is priced accordingly.

The two are also difficult to compare directly because they annualise differently. An advance at a factor rate of 1.25 cleared over twelve months works out at an APR equivalent of around 53%, and the same rate cleared in six months is closer to 120%. Invoice finance charges are already time based, so the equivalent figure depends mostly on your customers' payment behaviour and on how much of the facility you actually draw.

One consequence is worth flagging. If your customers pay slowly, invoice finance costs more and a merchant cash advance costs the same. If your customers pay quickly, invoice finance is very cheap and an advance repaid at the same speed is very expensive. The products respond to speed in opposite directions.

A merchant cash advance is the better fit where most of your revenue is taken by card at the point of sale, your trade is seasonal or variable, you have limited or no invoice book, and you want funding decided against card data rather than accounts. Hospitality, retail, personal care and leisure sit here almost by definition.

Invoice finance is the better fit where you sell to other businesses on credit terms, your working capital problem is the gap between delivering work and being paid for it, your customers are creditworthy, and your funding need is ongoing rather than a single lump sum. Wholesale, recruitment, construction services, logistics and professional services sit here.

There is a diagnostic question that cuts through most of it. Is your cash flow problem that you have not made the sales yet, or that you have made them and are waiting to be paid? The first points to an advance. The second points to invoice finance, and taking an expensive advance to bridge a gap that a cheaper invoice facility would close is one of the more common and avoidable funding mistakes we see.

Plenty of businesses do. A wholesaler with a trade counter, a garage with retail customers and fleet accounts, a bakery supplying cafes as well as walk in trade. In that position both products are available and the question becomes which side of the revenue is larger and more reliable.

In practice, providers will size the facility off whichever ledger they can see. A funder will advance against your card takings only, so if cards are 20% of revenue the advance will be small relative to your needs. An invoice finance provider will fund against your business to business ledger only, so if that is the minority of turnover the facility will be correspondingly limited. Running both is possible, but check for exclusivity or negative pledge provisions in either agreement before you commit to the first one, since some facilities restrict what other funding you can take.

Where neither is a clean fit, it is worth looking wider. Our page on alternatives to a merchant cash advance covers revolving credit facilities, overdrafts and asset finance, and revenue based finance is a useful middle option for businesses whose revenue arrives through mixed channels rather than card terminals alone.

The failure modes differ, and this is where the small print earns its attention.

Most invoice finance in the UK is provided with recourse, meaning that if your customer does not pay within an agreed period the debt comes back to you and the advance has to be repaid. Non recourse facilities exist and shift some of that credit risk to the provider, usually at a higher price and with conditions attached. Facilities are typically secured by a charge over your book debts, and often by a debenture, which affects what other funding you can raise.

A merchant cash advance is usually unsecured against assets but very commonly supported by a personal guarantee, and the funder's real security is the holdback arrangement itself. The risks to watch are minimum payment or shortfall clauses, which can convert a flexible product into a fixed obligation, and the requirement in some agreements to move your card processing to a particular acquirer. Taking a second advance while a first is still running is the single most damaging pattern in this market, because the combined holdback can strip a quarter or more from every card transaction.

Both products sit largely outside the consumer credit regime when provided to limited companies. A merchant cash advance is a purchase of future receivables rather than credit, so it falls outside the Financial Conduct Authority's consumer credit perimeter, and most commercial invoice finance is similarly unregulated business lending. Sole traders and some small partnerships may fall within the Consumer Credit Act depending on the size and purpose of the agreement.

The practical consequence is the same for both: no obligation to quote a standardised annual cost, no prescribed pre contract disclosure and no consumer complaint route. That makes the comparison work yours to do. Get the total pound cost of each option over a realistic period, on one sheet, before you decide. Our page on merchant cash advance rates sets out what to ask a funder for, and the same discipline applies to an invoice finance quote: service fee, discount charge, advance rate, minimum term and every exit fee.