Should You Use Invoice Factoring or Overdraft for Your Business?

If you run a business, I’m sure you have applied for an overdraft, and possibly compared an overdraft to an invoice factoring facility.

In the last few years banks have become increasingly reluctant to offer credit facilities as their lending criteria has become more and more rigid. As a result, businesses have had to shop around for other forms of finance, that’s where factoring comes in. On a daily basis we get asked what is more beneficial for businesses, factoring or a bank overdraft. There are a few differences in the two products which we have detailed below.

A Business Overdraft

An overdraft used to be the main source of business finance stretching back around 15+ years ago. But as time has moved on more & more financial products have been created and brought more into the limelight to keep up with the modern business. 15+ years ago there wasn’t as much choice as there is today so more often than not business owners will always consider an overdraft over other forms of finance purely out of habit.

Allot of the downfalls of an overdraft are overlooked, such as an overdraft can be withdrawn at short notice and banks have the right to cancel an overdraft within days. This reason alone has caused problems for firms of all shapes and sizes in the last few years. An overdraft facility has a limit which is based on past history of your business, which in itself is an issue with more than 500K new business being started every year. As your business grows, you’ll need more working capital and getting that overdraft increased will take time and your application may well be rejected because you may be in what the “banks” deem as a high risk industry or you may have exceeded your limit as overdrafts are not a flexible product.

While getting an overdraft is flexible you can only borrow what you need, it can be expensive and trap you into a false sense of security. If you don’t carefully manage your overdraft facility and end up exceeding your limits you’ll be exposed to very hefty charges. Over the last five years banks are not giving out an overdraft very easily. Banks now have a higher decline ratio than they did in the past and in allot of cases are pushing their clients towards their in house invoice financing.

An Invoice Factoring Facility

Factoring or Invoice Finance as its also known is a product that has been around for decades but up until the late 90s, the product wasn’t seen for the benefits it brings to a business. In some cases with certain industries Factoring is still seen in this light, but for the most part more and more businesses are turning to this method of finance to help ease the burden of their businesses financial future.

In 1994 the number of businesses that used an asset based finance facility (factoring, Invoice Discounting) was 11,807 businesses. By the end of 2013 that figure is 43,485 businesses and that figure is predicted by the bank of England to increase. Clearly Factoring is being utilised more by the modern business given the industry has quadrupled in size.

As time has moved on more businesses are seeing factoring for the added value it brings to businesses of any industry such as, Factoring is a flexible form of finance that grows in line with your sales. Factoring companies look at a wide variety of businesses but each individual funder has industries and credit ratings that they will look at better than other industries, some will want customers of a particular size of turnover or level of profitability but as long as you are invoicing another business there will generally be a funder who can provide factoring for your business. This is one of the reasons why it is useful to engage a broker to help source the most appropriate funders. It is important that you choose your factoring company carefully to make sure they are approachable and flexible.

After studying both forms of finance we have come to the conclusion that factoring is overtaking an overdraft as a sustainable source of finance. Even mainstream banks are pushing their clients towards factoring instead of overdrafts.

I hope the above has helped your diction in what type of facility to look for. If there is anything we can help with please don’t hesitate to get in touch.

Information Sources

[1] abfa.co.uk (Asset Based Finance Association)

[2] startupbritain.co