Comparing Invoice Finance and Overdrafts
During the financial crisis when bank lending was restricted and made less accessible to the UK’s smaller businesses, many business owners short on working capital were forced to look elsewhere to boost cash flow. Invoice finance (factoring and discounting) became more popular and less stigmatised, and today it is increasingly taking market share from traditional business loans and overdrafts.
Invoice finance meets the requirements of a range of businesses looking to raise finance quickly and flexibly. It is typically structured as factoring and invoice discounting, which is similar and yet different. In a factoring agreement, the provider manages the debtor book and credit control, making it more suitable to higher risk smaller businesses, such as start-ups and Phoenix businesses that have struggled with bad debt in the past. These higher risk businesses typically operate on tight margins, therefore, protecting cash flow is vital to their survival.
Invoice discounting shares many of the same benefits of factoring. However, it is more suited to established businesses with larger turnovers that have robust financial procedures in place. In an invoice discounting agreement, the business continues to manage the sales ledger and credit control so customers remain unaware that an invoice finance facility is in place.
So how does invoice finance stack up against an overdraft?
Invoice Finance Advantages
Invoice finance is suitable for businesses that have been turned down by the big banks, has some history of bad credit or simply needs to improve cash flow as it enables the business to access funds as soon as the invoice is issued, rather than waiting 60 or 90 days.
One of the key benefits of invoice finance is that the amount released is high at around 90% of the debtor book, which is advanced to the business within 24 hours. Unlike a bank overdraft., which is for a fixed sum pre-arranged with the bank, invoice finance is revolving facility and as sales grow so does the amount that can be borrowed as it’s flexible. A facility can often be set up within 48 hours.
Invoice Finance Disadvantages
Traditionally, SMEs have been put off invoice finance because they have been required to commit all or a large proportion of their unpaid customer invoices to the factor or invoice discounting company. These days selective invoice financing brings the considerable benefit of more flexibility by allowing businesses to retain control of their ledgers by choosing which invoices to sell as and when required.
That said, invoice finance requires more administration in-house than an overdraft and if the business doesn’t get the agreement right, this can cause a problem that is difficult to address.
Businesses naturally gravitate to the high street banks, and overdrafts are one of the most well-known routes to finance available and frequently the option that business owners consider first. This is because they are quick and easy to set up if there’s no charge over freehold property. However, they must be formally arranged in advance to avoid a penalty.
Once an overdraft is in place, it needs to be carefully managed or the business will be at risk of hefty charges. However, one of the main benefits of overdraft lending is that the bank only approaches the business periodically for management figures. In the majority of cases, overdraft lending is cheaper than invoice finance on a like-for-like basis.
SME overdrafts can be reduced and even withdrawn by banks at any time. Additionally, overdrafts are repayable on demand, therefore, it’s hard to have any confidence or security in this type of lending in the longer term. Another downside is that the banks don’t like to increase overdraft limits even when the finance will be used to support growth. They can also increase fees without negotiating with the business.
Every business is different and what’s right for one is frequently not suitable for another. For accurate guidance on how to raise finance for your business, please call 08000 24 24 51 or email firstname.lastname@example.org for free and confidential advice from one of our professional advisers.