Delayed invoice payments combined with upcoming payroll and business costs, can be frustrating and destabilising for many SMEs – having a significant impact on cash flow and their ability to operate and invest.
As 41.8 per cent of SMEs have experienced late payments, according to previous OECD reports, exploring credit facilities can help bridge gaps in working capital.
If your business needs a cash boost, invoice financing and overdrafts serve similar functions, but are best applied to different situations.
How does invoice financing work?
Invoice financing works by a lender using unpaid invoices as collateral for funding.
Lenders can advance up to 95 per cent of an invoice’s value almost instantly, instead of businesses having to wait 30 days, 60 days or even longer for payments.
The remaining balance of an invoice’s value will be available upon client payment, but lenders will deduct their service charge and fees depending on the value of the advance.
One of the main attractions of invoice financing is that it doesn’t add to existing debt, which is good for SMEs that can’t or don’t want to borrow from a bank.
However, if your margins are already narrow, you might not be able to use these invoice financing, as the fee structures can sometimes outweigh the cash flow benefits.
Where this is the case, it may be worth considering a business overdraft.
What are business overdrafts?
A business overdraft is a pre-arranged credit facility linked to a bank account, which allows you to spend more than the balance available, up to an agreed limit.
Where an overdraft is used and a balance turns negative, interest will be charged on the amount borrowed from the bank.
For UK businesses, interest rates typically range from the Bank of England base rate plus two to four per cent, up to 15 per cent or more, depending on the lender and current demand.
Overdrafts can be useful as they are relatively straightforward.
You draw funds when you need it and you are only charged when your balance turns negative, without the hassle of per-invoice admin.
However, businesses are vulnerable to banks reducing or withdrawing borrowing limits based on demand, which can sometimes be at very short notice.
Account limits are determined based on your business’s financial health and relationship with the bank.
Established relationships receive more favourable borrowing costs and higher credit ceilings, so the applicability of an overdraft is often situation specific.
Which is the right choice?
Both credit facilities can provide the short term cash needed to keep your business afloat, but each has different criteria and use cases.
Invoice financing could be the better fit if:
You may want to consider an overdraft if:
While invoice financing and overdrafts have their own applications, they aren’t mutually exclusive.
Invoice financing can cover the predictable gap caused by late paying customers, while an overdraft acts as the buffer to cover any unexpected cash flow shocks.
You should speak to an accountant to ensure your credit facilities are structured correctly, allowing you to meet liabilities and avoid unnecessary borrowing costs.
Speak to our financial experts
Our specialists can forecast your cash flow to determine if shortfalls are recurring or occasional, advising whether an overdraft or invoice financing is the smarter choice.
Where cash flow gaps have been identified, we can help address structural problems and offer other solutions that can prevent further borrowing and debt.
