A question often posed to me is which is better for a business, an overdraft or invoice finance ? Despite what I read from others I have strong views on this and firmly believe there is no definitive answer. However, here’s my thoughts:
The advantages of an overdraft:
- Overdrafts are flexible as long as you stay within the limit.
- The bank leaves you alone without much control with the exception in some cases of periodic management figures.
- In the majority of cases they are cheaper than an invoice finance product on a like for like basis.
- Usually cheap, easy and quick to set up if no charge over freehold property.
Invoice Finance advantages:
- As your sales grow so does the amount you can borrow, the limit in place for Invoice Finance is very flexible.
- Invoice Finance enables funding for start-up businesses and for businesses that have struggled / have bad credit history.
- The amount you can borrow with Invoice Finance is typically high at around 80% over your gross debtor book.
- Usually a personal guarantee is required for Invoice Finance, but in 99% of cases no charge over freehold property is required.
- Funding is being reduced and overdrafts are repayable on demand so no confidence in this facility long term.
- The value of a Debenture to secure a cash flow lend has reduced. Therefore, banks are less likely to lend without freehold security and at some time in the next couple of decades it is widely believed overdrafts will be gone.
- When assessing risk the first place the Banks look at overdrafts and will reduce limits or increase fees without negotiation.
- Banks will typically fund a maximum of 40% of debtors on an overdraft.
- The overdraft limit is the limit. Banks are not keen to increase limits even if it is to support sales growth.
Invoice Finance disadvantages:
- Invoice Factoring still has a bad reputation with the minority from when it was lending of last resort.
- It is more expensive than overdraft lending on a like for like basis.
- There is more administration required in house than with an overdraft.
- If you don’t get the invoice finance agreement right at the start this may cause big problems in the future.
- With Invoice Finance, there is no regulation so if you are with the wrong lender and you step out of line fees can be extremely high.
Invoice Finance vs Overdraft – Summary
In summary, if you are a static turnover business that already has an overdraft that is sufficient or a bank willing to lend more on overdraft then this will likely be the best way of managing your cash flow for the cheapest possible price.
If this doesn’t describe your business then it is worth the discussion whether invoice finance will work for you, we often find that the extra amount you can borrow from invoice finance far outweighs the benefits of an overdraft.
What must be remembered is that each business is different and what is right for one is not right for another, only by getting an independent view point from a professional brokerage will you get an accurate assessment.
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