Invoice Finance (both factoring and discounting) became popular during the financial crisis of 2007, during this period banks started to withdraw businesses overdrafts and lending became extremely difficult in the UK.
This meant owners of small businesses had a difficult time getting their hands on cash and began to look elsewhere to obtain working capital that would boost their cash flow.
Furthermore, Invoice Finance has now reached a point of heightened popularity and is beginning to take a section of the market share away from traditional business loans and overdrafts.
Most businesses owners are familiar with how bank overdrafts work. It’s a fixed credit facility companies can utilise when they want to spend more money than is actually in their account.
Comparing Invoice Finance with Overdrafts
Regardless of what the needs of your business venture may be, the flexibility of Invoice Finance allows it to fit into almost any scenario. It typically comes in the two following forms: Invoice Factoring and Invoice Discounting. While these two products are similar, they have several key differences also.
Throughout a Factoring arrangement, the provider will manage the debtor book and credit control will remain with them, this makes it suitable to higher risk small business ventures, much like start-up ventures that have struggled with financial issues in the past.
All higher risk companies will operate under tight margins, meaning they need to protect cash flow as much as they can in order to survive.
The key change here is that the responsibility for the collection of the sales ledger, payment chasing, and invoice processing stays with you if you use an invoice discounting facility. As a result, the facility is confidential, and your customers are unlikely to be aware of your relationship with the lender.
Usually, a third-party bank account is set up for payments to be made into, by using this package it’s like having a business overdraft facility that’s secured against your accounts receivables.
Advantages of overdrafts
Here are the key advantages to an overdraft facility:
- They can offer decent flexibility within agreed limits
- You can arrange one quickly and easily
- You can normally pay off an overdraft early without being hit by extra costs
Business owners often gravitate towards high street banks as they see them as both safe and trusted. Overdraft facilities are one of the most commonly available finance options provided by a traditional bank. They are easy to set up and the process can be very quick, so people believe they are going to get the financial boost they require very fast.
Once you have obtained an overdraft, your business must be very careful not to run into any of the hidden charges that can be attached to them. However, usually, overdraft lending is cheaper than Invoice Finance when compared on a like-for-like basis.
Disadvantages of Overdrafts
- Banks can request the money back at any time
- Making an extension to your overdraft can be very costly, so you’ll need to stick to your agreed limit to avoid paying a hefty fee
- High street bank lending criteria can be very strict, and difficulty being accepted is becoming increasingly common
- Commercial overdrafts often need to be secured with collateral security
You will need to be aware that SME overdrafts can be reduced or fully withdrawn by banks at any given time. Also, the money you lend through the use of your overdraft will be repayable on demand, meaning that you may end up having to pay large fees at points in time you would never have expected to.
Additionally, a further negative point is that the banks don’t like to increase overdraft limits at any point, even when the finance will be used to support the development of your company. They can also increase fees without negotiating with you, the business owner, which again can take you by surprise when you least expect it.
Advantages of Invoice Finance
Next, we move onto Invoice Finance to see how it compares. The popularity of this has grown tremendously over the past few years, which is largely due to the level of flexibility it offers to customers.
The key advantages of Invoice Finance are as follows:
- Borrowing limits are highly flexible and can either decrease or increase depending on your sales ledger
- If your business has a poor history of credit, you will still have access to this form of funding
- You can borrow much higher amounts than an overdraft will allow you to
- There is no requirement of asset-based guarantees
Invoice Finance is the perfect solution for business ventures that may have been turned down by banks after applying, or that have a history of bad credit/financial troubles. If you need to improve cash flow, this is likely going to be a great method for you to utilise.
A main benefit to Invoice Finance is the amount of cash it releases. Around 90% of the debtor book is advanced to the company within a period of 24 hours. Unlike overdrafts, Invoice Finance is not a fixed, pre-arranged sum that cannot be altered to align with your changing situation. As your sales grow, so will the amount that you can borrow, meaning that this funding option keeps up with the development of your company.
Disadvantages of Invoice Finance
- You will gain a marginally reduced level of profit from the sale of your orders and services
- At first it can seem like a costlier alternative to an overdraft
- It is seen by some that there is a stigma attached to Invoice Finance, which occasionally puts borrowers off
- Invoice Finance lenders will only purchase commercial invoices, this makes it difficult for those that sell directly to the public
Invoice Finance requires further amounts of administration and in-house than an overdraft does. If the company fails to get the agreement right, problems can be created that prove to be difficult to address.
In conclusion, both invoice finance and business overdrafts offer valuable financial solutions to address the cash flow challenges and financing needs of businesses. Invoice finance provides a means to access immediate funds by leveraging outstanding invoices, enabling businesses to maintain a steady cash flow and invest in growth without incurring additional debt. On the other hand, a business overdraft offers flexibility and readily available credit, providing a safety net for unforeseen expenses or short-term liquidity gaps.
The choice between the two options depends on a business’s unique circumstances, financial goals, and risk tolerance. Ultimately, selecting the appropriate financing method can empower businesses to navigate financial hurdles effectively and seize opportunities for growth and success.
Seeking expert advice and carefully assessing the specific requirements will help businesses make the most suitable decision for their financial well-being.
Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.