Businesses have never had so many funding options as they do today, which is undoubtedly a good thing. However, so much choice can create its problems.
Overdrafts have served most businesses well over the years, but they’re not without their limitations. For example, an overdraft facility can be withdrawn at any time. The limit is also fixed, so if you need access to more funds, you may have to go through the application process again.
Invoice finance (invoice discounting and factoring) has gone from strength to strength over the last few years. As businesses have woken up to the benefits of this form of finance, more and more invoice finance providers have entered the market. That has increased the level of competition and led to improved service levels and reduced costs across the board.
There are now more than 50 invoice finance providers in the UK, making it a viable funding option for businesses large and small. Find out more about how invoice finance works.
But which finance option, invoice finance or overdraft, is better suited to your business? Here’s our impartial assessment of the benefits and pitfalls of each.
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Invoice finance is an umbrella term that describes several products, of which invoice factoring and invoice discounting are the most widely used. Of the two, invoice factoring is less like an overdraft because it offers more than just a funding option.
In an invoice factoring facility, the finance provider takes over the credit control process on the business’s behalf. For small businesses that don’t have the time or struggle to collect payments promptly, this can be a very useful addition.
However, on the downside, you will lose an element of control over your business and your customers will know you are working with a finance provider.
Invoice discounting, on the other hand, can be a completely confidential agreement, and your customers never need to know you’re working with a third party. So, if you’re looking for a service that’s comparable to an overdraft, this is most likely to be it.
However, the drawback with invoice discounting is that it’s only really an option for established companies which sell to large customers and have an efficient credit collections process in place.
Most people are very familiar with how overdrafts work. It’s a facility business can dip into when they want to spend more money than is actually in their account.
As long as there is a prior agreement in place with a bank and the amount you take is within the authorised overdraft limit, then interest is charged at the agreed rate. If the negative balance exceeds the agreed terms, then higher rates are likely to apply.
The ease of use and flexibility overdrafts offer has made them a popular source of working capital over the years.
Invoice Finance vs. Overdrafts – How do They Compare?
- Invoice finance – Flexibility is one of the biggest benefits of invoice finance because the funding limits grow with your turnover. There are also options, such as selective invoice discounting and spot factoring, that allow you to pick and choose which invoices you want to raise finance against, rather than committing your whole sales ledger.
- Overdrafts – Although overdrafts give businesses quick access to cash, they are not particularly flexible. If you want to increase your funding limits, this will have to be renegotiated with the bank. Some banks are also reluctant to extend overdrafts in the current climate, even if it’s to finance growth.
- Invoice finance – It can take a few weeks to put an invoice finance agreement in place. Once it is set up, finance providers can advance you up to 95 percent of the value of an invoice within 24 hours of it being issued to a customer.
- Overdrafts – Overdrafts are quick to set up, although there can be a lengthy application process and a wait for a decision to be made. Once the overdraft is agreed it can be used immediately.
How Much can you Borrow?
- Invoice finance – Invoice finance agreements allow you to release up to 95 percent of the value of an invoice within 24 hours of it being sent to a customer. Some invoice discounting providers will even pay you 100 percent of the invoice’s value. As the business grows, so does the amount you can borrow.
- Overdrafts – Overdraft limits can be an obstacle if you need more money than your limit allows. To increase the limit, you will often have to reapply, which will take time. For that reason, when applying for an overdraft, make sure the initial limit will cover your financial needs.
- Invoice finance – Invoice factoring is more expensive due to the additional credit control aspect of the service. You’ll typically pay 1.5 to 3 percent over the base rate on the advance and fees of 0.75 to 2.5 percent of your turnover. In an invoice discounting agreement, you will pay 0.2 to 0.5 percent of your turnover as a fee, plus interest on the advance.
- Overdrafts – If you stay within your overdraft limit, you’re likely to be charged around 3 percent over the base rate on the money you borrow and possibly a one-off fee of around 1.5 percent of the agreed overdraft limit. If you exceed your limit, you could face a one-off charge and interest of 30 percent. However, generally speaking, overdrafts tend to be the cheaper option.
- Invoice finance – In many cases, the only asset required to secure the funding is the invoice itself, although some finance providers will ask for a personal guarantee.
- Overdrafts – Commercial overdrafts usually need to be secured with property or machinery.
- Invoice finance – Invoice factors provide their credit control function, which means smaller companies and even start-ups are often accepted. Decisions about invoice discounting are based on the creditworthiness of a business’s customers, rather than the business itself. That means those with low credit scores or an imperfect trading history can apply.
- Overdrafts – The bank’s lending criteria can be strict, and businesses with low credit scores may struggle to obtain an overdraft. When assessing risk, banks may also reduce overdraft amounts or increase fees without negotiation.
Invoice Finance or Overdraft: Which is Right for Your Business?
While regular bank overdrafts are easy to find and compare, there may be more suitable and cost-effective short-term funding options that are better suited to your business’s needs. If you’re not sure which is the right funding method for your business, we have many resources available on our site. Please get in touch if you’d like to discuss your options.