What is the factor rate on MCA and how to calculate that?

Jason Hunt
March 22, 2024

Have you ever considered how small companies secure rapid funding to support their business operations?

Think about this: Sarah, who owns a small business, is in a crisis of funds to buy more of her supplies. Many entrepreneurs use MCA to score a fast cash boost in such situations.

But what is the factor rate of MCA and how is this different from the traditional interest rate?

Understanding Factor Rate

Understanding Factor Rate

The advance cost can be calculated by calculating an MCA’s factor rate. Instead of being an interest rate, it is a decimal number that typically ranges from 1.1 to 1.5.

Simply put, the factor rate is the total sum a company owner must pay back in addition to the loan amount.

Calculating Factor Rate

Using factor rate, it is simple to calculate the total repayment amount. Let’s look at a simple example:

Joe is a small business owner. Suppose he secures an MCA of $10,000 with a factor of 1.3.

To calculate the total repayment amount, you have to multiply the loan amount by the factor rate.

Total Repayment = Loan Amount × Factor Rate
                = $10,000 × 1.3
                = $13,000

In this particular case, Joe will repay $13,000 in total, which includes the $10,000 loaned and factor rate.

Comparison with Interest Rate

Comparison with Interest rate

It is important to distinguish between the interest rate and the factor rate, which are represented by decimal numbers.

On the other hand, interest rates are a percentage of the loan amount charged over a specific time frame. These two are then multiplied to find out the total repayment amount.

For example:

Sarah takes out a traditional loan of $8,000 with an interest rate of 8% over one year, her interest payment would be:

Interest Payment = Loan Amount × Interest Rate
                 = $8,000 × 0.08
                 = $640

Interest rates differ throughout the loan period, compared to factor rates. In contrast, factor rates are applied at the beginning, providing borrowers with a clear picture of the total cost upfront.

Converting Factor Rate to APR (Annual Percentage Rate)

The factor rate provides a transparent and upfront view of the total amount of repayment required. APR conversion makes it simpler to do comparisons with traditional loans. The formula for converting the factor rate to APR is:

APR= [math](\frac{Factor Rate}{Loan Term}) × 365 × 100[/math]

Let’s apply this formula to Joe’s scenario. If Joe’s MCA has a term of 6 months, the APR would be:

APR = (1.3/6) X 365 X 100
APR = 79.08%

How is The Factor Rate Determined?

A key element in calculating the total repayment amount is the factor rate. The factor rate is a multiplier applied to the borrowed amount rather than an interest rate.

It’s important to remember that MCAs have an entirely different repayment plan than standard loans.

Here’s how the factor rate is typically determined in an MCA:

1. Risk Assessment

MCA providers analyze the risks related to an organization based on factors like industry, period of operations, reliability, and financial state in general.

If necessary, they take into consideration the average daily credit card sales.

2. Underwriting Process

The underwriting process includes an in-depth review of the company’s cash flow, credit history, and financial record.

Using this information, MCA providers evaluate the level of risk they’re considering when lending money to the company.

3. Factor Rate Assignment

The MCA provider chooses a factor rate, normally from in the range of 1.1 to 1.5 after analyzing the risk and underwriting procedure.

This rate shows the amount the company must repay overall throughout the loan period, including fees.

4. Total Repayment Calculation

The MCA determines the total amount to be repaid by multiplying the borrowed amount by a factor rate. Unlike traditional loans with fluctuating interest rates, MCAs have a fixed repayment rate regardless of repayment speed.

Total Repayment = Borrowed Amount Factor Rate

5. Repayment Structure

MCAs can be repaid in two ways: through a percentage of daily credit card sales or fixed daily/weekly withdrawals from the business’s bank account.

Compared to traditional loans, MCA repayment periods are generally shorter, from a few months to a year.

Pros and Cons of Factor Rates

Pros

  • Quick Access to Funds
  • Flexible Repayment
  • No Fixed Monthly Payments
  • Easier Approval
  • Simple Application Process

Cons

  • High Cost of Capital
  • Lack of APR Transparency
  • Daily Repayment Structure
  • Potential Debt Cycle
  • Risk to Business Assets

Conclusion

Entrepreneurs need to understand the factor rate on MCAs when it comes to startup funding. Converting the factor rate to APR thoroughly explains the total expenses.

Keep in mind that factor rates are not similar to interest rates. Understanding the difference and learning how to convert to APR to handle finance is necessary.

With this understanding, you can prepare to make smart financial choices that will promote your company’s growth and success.

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Jason Hunt

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