For businesses with cash flow shortages, both invoice finance and traditional overdrafts offer a useful and effective solution. There are, however, distinct advantages and disadvantages to each which this article will aim to cover.
Advantages of an Overdraft Facility
Overdrafts have several distinct benefits.
- Within agreed limits, they offer a high level of flexibility
- They are fast and simple to arrange
- There are usually no fees for paying off an overdraft earlier than expected
Disadvantages of Overdrafts
- The bank can ask for the money back any time
- Extending the overdraft beyond the agreed limit can be costly at around 29% is common and sometimes impossible.
- Where it is permissible, many institutions require you to go through the entire application process again.
- Commercial overdrafts must sometimes be secured with collateral security (usually property or machinery)
- The bank’s lending criteria can be strict – many businesses with low credit scores or imperfect trading history may struggle to obtain one.
- The overdraft will have to be negotiated if your business grows and is not guaranteed to be granted
Advantages of Invoice Finance
Invoice finance has been one of the real growth industries of the Fintech boom. One of the reasons for this has been its ability to offer a more flexible solution for many businesses that would not qualify for traditional overdrafts.
Invoice finance advantages include:
- Borrowing limits are hugely flexible and can increase or decrease as per your sales ledger
- Invoice finance is an option for businesses with poor credit history
- In most cases, no asset-based guarantees are required
- Amounts available can be much higher than an overdraft
Disadvantages of Invoice Finance
- Invoice finance lenders will usually only buy commercial invoices, thereby making things difficult for businesses which sell directly to the public
- You will be running a marginally reduced profit from orders or services you provide
- At first glance, it can appear costly besides an overdraft.
- Some borrowers are concerned there may be a stigma attached to invoice financing
Which is a better option: a bank overdraft or invoice financing?
This is, needless to say, an impossible question to answer since every business is circumstances will be different. For businesses with an agreed overdraft from a reliable bank, then it would be difficult to argue the need for invoice financing. However, if your business is slightly higher in risk, or you are growing at a rate which makes your cash flow perilous to the future of the business, and invoice finance is a reliable, safe, and effective means of keeping things in play.
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