Facing financial hiccups while running your business is completely normal. No matter how established your business is, cash flow shortages can happen. Whether because of overdue clients’ payments or a slow business season. Fortunately, many financial solutions are available in the market, and MCA is one of them.
What is Merchant Cash Advance?
Merchant Cash Advance is a financial agreement in which a financial provider purchases your future card sales. In return, you receive a sum of money (advance) at once. The repayment amount includes the advance plus an MCA fee (factor rate). The repayment terms can either be weekly or monthly which is decided between you and your provider at the time of agreement.
The catch with MCA is that it’s only applicable to your business’s card sales. So, the amount of advance also depends on your transaction volume and profitability.
Do you need a Merchant Cash Advance?
Why is MCA a Liability?
You probably have heard this before, “MCA is not a loan”. Technically it’s true because a loan sets you up with a lump sum and charges monthly interest but MCA gives you funds based on your sales potential and cuts a fixed percentage of your weekly/daily card sales. Moreover, MCA providers also don’t label the MCA service as a loan.
But every payable amount that will result in cash outflow in the future is called a liability from a business owner’s perspective.
So the first key point is this: MCA is recorded as a liability in your financial statements.
Let’s consider an example of a business that received £10,000 as an MCA advance with a factor rate of 1.2. The total payable then will be £12,000.
Journal Entry
The first step is when your business receives the advance amount. According to what we have learned, it should be recorded as a liability because you are obligated to repay it.
- Debit: Bank Account £10,000
- Credit: MCA Liability £10,000
At this point, we are only acknowledging the amount received, without including the fee.
Recording the factor rate
Now, let us tackle the fee for the MCA. The factor rate is treated as an expense in your financial statements.
Instead of expensing the full MCA immediately, businesses record the fee gradually with the repayments. The MCA liability account should reflect the total repayment amount, which includes both the advance and the factor rate. In the case of our example, it is £12,000. When making repayments, businesses must divide the payment between reducing the liability and recognizing the factor rate expense. How? We will circle back to it later in the blog.
Recording MCA Repayments
Depending on your provider, your repayment schedule can differ. As weekly/monthly payments are deducted, your liability will automatically decrease. Let’s assume that the business in question repays £1,000 per week, then the journal entry can be written as:
Journal Entry
- Debit: MCA Liability £1,000 _ Reducing debt
- Credit: Bank Account £1,000_Cash outflow
Now at this point, we are yet to acknowledge how to split the repayment into the principal amount (reducing the liability as worded earlier) and the factor fee. That follows up immediately after this section.
How to account for the automatic repayment deduction in the sales account?
With MCA, the repayments get deducted from your sales account automatically. But you should never understate your sales in your books. Let’s make this concept simple to understand by continuing our example scenario. The business in our example had paid £1,000 in repayments each week.
Here, we have to understand that each repayment consists of a principal repayment (that reduces the actual liability) and a factor fee (recorded as an expense). So we need a clearing account that holds the repayment sum before we accurately distribute it in the respective accounts. Here’s how it looks after we combine everything we have learned yet.
Summary
- Business took an MCA advance of £10,000 with a 1.2 factor rate (so total repayment = £12,000).
- Sales = £10,000 per week, and 10% (£1,000) is automatically deducted for MCA repayment.
Each repayment consists of:
- £X→ Principal (reducing MCA liability).
- £X→ Factor fee (expense).
| 1. Record the advance amount |
|---|
|
Debit: Bank £10,000 | Credit: MCA liability £10,000 |
| 2. Record Full Sales |
|---|
|
Debit: Bank £10,000 | Credit: Sales Revenue £10,000 |
| 3. Move the Repayment into a Clearing Account |
|---|
|
Debit: MCA Clearing Account £1,000 | Credit: Bank £1,000 |
| 4. Split the MCA Repayment Properly |
|---|
|
Debit: MCA Liability £X (reducing the debt) Debit: MCA Financing Expense £X (recognizing the factor fee) Credit: MCA Clearing Account £1,000 |
Steps in setting up merchant cash advance in your accounting system
1. Setting up a liability account
The first step in accounting for recording your MCA in your books is to set up a dedicated liability account. If you’re using accounting software like Xero or Quickbooks, this means creating an account under the liabilities section named “Merchant Cash Advance Liability.”
2. Recording the advance payment
When your MCA provider transfers advance funds into your bank account, record the exact amount as a debit in your bank account and a credit in the newly created MCA liability account.
3. Repayment tracking
MCAs are repaid directly through your merchant services, with a percentage of daily or weekly card sales. These repayments vary with sales, so create a streamlined process for recording them regularly. To do this, set up a recurring journal entry or a dedicated expense account for “MCA Repayments” in your accounting software.
In each repayment, you’ll record it as a debit to reduce the “Merchant Cash Advance Payable” liability and a credit to your bank account.
4. Recording factor rate
Set up a separate expense account for MCA fees in your accounting software. It’s best to acknowledge the fee as you make repayments instead of writing it off at the end of the MCA period.
5. Automate repayments
If you’re using accounting software that syncs with your bank or merchant account, you can also automate these entries. Many accounting platforms allow you to set up rules that automatically categorise and record transactions.
6. Perform monthly reconciliations
Compare the “Merchant Cash Advance Payable” account with your bank account deductions to confirm the accuracy, each month. If any repayments are missing, you can adjust them, to reduce any errors.
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FAQs
Here’s some important information to keep in mind.
- For businesses, MCA is a loan even though the providers do not explicitly mention it.
- Record the advance amount in liability/ accounts payable.
- When you receive the amount, debit the bank account and credit your liability.
- The fee should be recorded as an expense in the financial statements.
- Don’t understate your sales account.
- Credit your bank account and debit your liability as you make weekly or monthly payments.
To exit an MCA early, negotiate a settlement directly with your MCA provider. This usually requires a full repayment of the outstanding balance and any associated fees. Some providers in the UK may inflict a fee for terminating your MCA contract early.
When the MCA repayments are deducted directly from sales, it’s easy to misrecord them by reducing sales revenue, which isn’t accurate. Instead, a clearing account temporarily holds the sum to make sure the repayment amount is correctly split between reducing the MCA liability and recording the factor rate as an expense. This helps maintain clarity in financial statements and prevents understating your revenue in your books
