Business overdraft alternatives: what are my options?

Old-fashioned bank overdrafts are a useful cash flow solution, but they’ve become more difficult to access as banks have been reluctant to lend. As a business owner, it’s easy to take it personally if an overdraft is refused or reduced, but it’s not just you. There are promising business overdraft alternatives out there – here’s our guide to some common, and some lesser-known, alternatives to a business overdraft:

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Business overdraft alternatives: what are my options?

As a business owner, you will know that there are times when you need to spend more than what is currently available in your business current account. It might be to cover an unexpected bill or an item of stock that ran out faster than expected. In times like these, many people in charge of the finances of a business will turn to bank overdrafts. However, business overdrafts carry high interest rates, especially if the overdraft balance is not repaid in full by the end of the month — which is sometimes not practical. Luckily, there are several alternatives to a business overdraft that might better suit your needs. In this article, we’ll discuss merchant cash advances, factoring and invoice discounting, revolving credit facilities, and invoice finance.

Merchant cash advances

A merchant cash advance is a novel form of short-term business finance that allows a business owner to access a fixed amount of cash from a merchant cash advance lender. The borrowed amount is then repaid with fees as a proportion of future revenue. They can either be structured as a percentage of card sales or as fixed withdrawals from a bank account. The amount of the advance can range between £2,500 and £300,000 and will depend on your average monthly customer card turnover. The higher the card sales you transact, the bigger the cash advance you can receive. 

A merchant cash advance will suit many different types of businesses given its flexibility i.e you can pay back the loan when you receive customer card payments, thus repayments are linked to sales so you can better manage cash flow. It will also suit businesses that need a fast application process — in most cases, you can get approved for an advance within 24 hours. This is a type of unsecured business loan, so you won’t need to put forward collateral, or valuable business assets. This will suit if you have little or no valuable assets like commercial vehicles, plant and machinery, or cash on hand. You will most likely be asked for a personal guarantee.

Some advantages of a merchant cash advance:

  • Quick approvals

  • Suitable for businesses with short trading histories

  • Flexible terms and amounts

  • Better cash flow management

  • Favourable interest rates

  • Works towards company credit history

  • Ideal safety net

Factoring and invoice discounting

Invoice factoring and invoice discounting are the two most common types of invoice finance, but what are they and why should I consider them as a business overdraft alternative? Let’s take invoice factoring first. Factoring is when invoices are sold to a factoring company, and invoice discounting is similar but the borrower keeps control of the administration of the sales ledger. When it comes to factoring a 3rd party will take over control of your sales ledger and assume responsibility for collecting any money owed to your business.

What is invoice factoring?

This is a form of invoice finance that allows a business owner to borrow money against customer invoices. Instead of waiting for payment, which could be up to 30 days, unless contractually agreed, you can agree to an upfront payment. Though in return the lender will expect fees for this service, which means you will have to offer a discount on outstanding invoices.

For example, Microchip Ltd is owed £100,000 from its customers, but it knows that they don’t usually pay until 30 days+ and some key machinery has broken down, which needs to be replaced immediately. Microchip Ltd can approach an invoice factoring lender and ask for an advance based on the outstanding invoices. The lender will typically ask for 80-90% of the value, after verifying that the invoices are valid. Usually, business owners will be drawn to invoice factoring for the following reasons:

  • Predictable cash flow — you can have your invoice paid immediately and avoid the risk of customers delaying payment beyond the standard 30-day payment window.

  • Cheaper than a bank loan — in most cases, invoice factoring works out cheaper than a traditional bank loan, making it a good short-term funding option for a small business. 

  • Reduce overheads — invoice factoring can work out cheaper than employing accounts staff to chase outstanding customer payments, including in the worst-case scenario the need to hire a debt collection service.  

Revolving credit facility

Also known as a line of credit, this type of business loan is suitable for small to medium-sized businesses that need flexible access to cash in the normal course of business. Business owners are drawn to this form of working capital finance for business transactions. The credit limit is fixed in the same way as a business credit card or overdraft facility. You can borrow money, purchase an item of stock, for example, and pay it off before the agreed date. The terms on offer will be dependent on the financial situation of your company. This type of lending is open-ended, you can borrow, repay, and repeat for the duration of the term, with no limits, other than the credit limit. This gives finance managers more control over borrowing when compared to other alternative finance lending options.

Invoice finance

The final type of lending that we will cover in this article is invoice finance. Similar to factoring and invoice discounting, invoice finance involves borrowing money backed by the accounts receivable owed to you from customers. This fast-tracks the payment of outstanding invoices and eliminates the need to wait for contractual payment terms. The difference between factoring and invoice finance is where factoring takes the entire outstanding sum, invoice financing takes only the invoices that you choose to sell. Hence, you retain control of your accounts receivable, and all administrative responsibilities.

Factoring tends to be more expensive than invoice finance as you are paying for a debt collection service, while with invoice finance your accounts department will still have to do this. Before applying for any type of lending, please always check that the company is regulated by the Financial Conduct Authority who currently regulates over 50,000 financial services firms and financial markets in the UK.

Business Overdraft Alternatives

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