How to Record a Merchant Cash Advance on Financial StatementsAugust 23, 2011 | By: Sean Murray
Work in the Merchant Cash Advance(MCA) business long enough and this question should come up every so often. How do you record a MCA on financial statements and for tax purposes?
Our discussions with numerous accountants have indicated that the method is not very uniform. It all depends on the person doing the books. From local bookkeepers, to large CPA firms, masters of the accounting universe seem to be making their best guesses and acting accordingly. That’s a discouraging thought.
We’d like to push business owners and their bean counting cohorts in the right direction and assist with the financial statements. A Merchant Cash Advance is not a loan. We repeat, A Merchant Cash Advance is not a loan! An overwhelming number of accountants book it this way because they fail to read the nature of the agreement. It is a buy/sell contract. Interest Expense and Loan Payable line items will not be necessary.
What Is being sold? Future Revenue. It may be a bit difficult to grasp, but it is more appropriate to compare a MCA to that of a traditional factoring transaction.
Factoring accounts receivable is a normal accepted business practice. It involves a business selling the cash due for sales already generated. In turn the factoring company pays the business cash upfront and charges a fee for the service. They are then responsible for collecting the cash.
Now let’s change a few words there to reflect the nature of a MCA and we’ll see just how close both financial transactions are:
Factoring future credit card sales revenue is a normal accepted business practice. It involves a business selling the cash it will receive for the sales it will generate. In turn the factoring company pays the business cash upfront and charges a fee for the service. They are then responsible for collecting the cash.
But to ensure that a sale of future credit card sales is really a sale, let’s make sure the proper steps were taken:
1. A true sale requires the buyer to protect and perfect their interest in the future credit card sale cash flow. This is done by filing a UCC-1 with the Secretary of State. Almost every Merchant Cash Advance(MCA) firm does this.
2. The purchaser must bear risk. That means the buyer must bear the risk that credit card sale cash flow may come in fast, slow, or not at all. This is normally accounted for by withholding a fixed percentage of credit card transactions. If the pace of credit card transactions declines, then the MCA firm will recoup their purchased revenues slower and have to deal with it.
3. There is no collateral.
It should be noted that the MCA firm only has to bear normalized risk as outlined in the respective MCA contract. They are not bound to bear the risk of a business owner breaching the contract and impeding their ability to recover their purchased credit card revenue. Once the agreement is breached, they have additional options at their disposal to collect.
The same would be said for a regular factoring transaction. If a business owner collects on Accounts Receivable that was sold to a factoring firm, they will be in breach of their agreement.
A business owner that deceptively uses a second credit card machine that is not connected to repay the MCA firm is essentially playing the role of a business owner collecting on Accounts Receivable balances that don’t belong to them. Once the sale is made, the business owner does not have the right to that cash flow.
Now let’s do the accounting for a very basic factoring transaction. ABC SERVICE CO has $100,000 in outstanding Accounts Receivable. They sell it to FACTORING CO XYZ. FACTORING CO XYZ assesses a fee of 30% of the amount of Accounts Receivable. FACTORING CO XYZ pays ABC SERVICE CO $70,000 and contacts their customers so they can receive the payments directly.
JOURNAL ENTRIES FOR ABC SERVICE CO:
DEBIT – CASH (ASSET) $70,000
DEBIT – LOSS ON SALE OF A/R(EXPENSE) $30,000
CREDIT – ACCOUNTS RECEIVABLE (ASSET) $100,000
We believe it would be more appropriate to book a MCA in a similar manner. This is not a formal financial or tax recommendation but rather insight that can point you in a more suitable direction.
ABC SERVICE CO has a strong business. They sell $130,000 of their future credit card sales to MCA CO. for the price of $100,000. MCA CO’s fee is the $30,000 difference. MCA CO pays ABC SERVICE CO $100,000 and contacts their credit card processor so they can receive the payments directly.
JOURNAL ENTRIES FOR ABC SERVICE CO:
DEBIT – CASH (ASSET) $100,000
DEBIT – LOSS ON SERVICE SALES (EXPENSE) $30,000
CREDIT – CREDIT CARD CASH FLOWS PAYABLE TO MCA CO (LIABILITY) $130,000
Record revenue in the same manner as you would. Book the cash, write $30,000 off as a loss on a sale, and record the rest as a payable.
Then for example: If $1,000 is generated in credit card sales and MCA CO is contracted to withhold 30% of each sale, do the following:
CREDIT – CREDIT CARD REVENUE (REVENUE) $1,000
DEBIT – CREDIT CARD SALES RECEIVABLES (ASSET) $1,000
CREDIT – CREDIT CARD SALES RECEIVABLES (ASSET) $300
DEBIT – CREDIT CARD CASH FLOWS PAYABLE TO MCA CO (ASSET) $300
DEBIT – COGS (EXPENSE): X
CREDIT – INVENTORY (ASSET) X
Financial Accounting is different than Tax Accounting. We’re not tax accountants. See factoring tax laws as a reference and use where applicable.
-The Merchant Cash Advance Resource
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Last modified: February 21, 2013
Sean Murray is the founder of deBanked, an 11-year veteran of the merchant cash advance industry, a casual Lending Club and Prosper note investor, the co-founder of Daily Funder, an alternative lending speaker, consultant, writer, and enthusiast. Connect with me on LinkedIn or follow me on twitter.