Invoice finance or overdraft for working capital?

Nowadays, there are many different ways of borrowing money to cover the timing difference that occurs between sales revenue being received and essential bills such as raw materials and salaries being paid.

Essentially though, these products break down into two main types:

  1. Facilities that are based on the invoices that you have issued
  2. General facilities based on the overall strength of your business.

Naturally, there are pros and cons to each and here, we will explain the differences to help you make the right choice for your business.

What is invoice finance?

With invoice finance, you sell some or all of your invoices to a finance provider that, in return, advances you a percentage of the value of those invoices. According to the terms of the agreement, the invoice provider might manage payment collection (known as invoice factoring) or that might be left to you (known as invoice discounting).

Advances are typically around 70% of the value of the invoice, with the balance being paid, less the finance provider's interest and fees, when the invoice is paid.

Security is normally a debenture over all of the assets of the business and personal guarantees from directors are often required too.

In some cases, the financing arrangement will be confidential, in others your customers will know that you are using invoice finance because they will be asked to make payments to a different business or bank account. They may also be contacted by that business if payment is overdue.

Benefits of invoice finance

The main benefit of invoice finance is that it is linked to, and can grow with, your turnover.

Credit limits and the cost of credit will be determined by a combination of the lender's assessment of your credit rating and that of your customers. Your lender's first concern is that the invoice will be paid, so if you are a relatively small business, but have secured a large enterprise like a supermarket or oil company as a customer, your ability to borrow could be much higher than if you were borrowing against the strength of your own balance sheet alone.

The ability to outsource credit control will be seen as a benefit by some businesses.

Things to look out for with invoice finance

Fees are the most important part of invoice finance to understand.

In addition to the interest on the money advanced, you will normally find there is an initial set-up or arrangement fee, an annual renewal fee and possibly also a non-utilisation fee. Additional fees can also be applied for exceeding or extending limits. These fees can quickly mount up so make sure you fully understand them.

Credit limits might also not be all that they appear to be as restrictions can be applied within the limit, for example if you have a large exposure to one customer.  This is known as a 'debtor concentration limit' and you could find yourself being advanced much less than you expect - or need.

Be aware too that an invoice finance facility is a contract that typically runs for 1-3 years. If it's no longer right for you and you want to get out of it early, it is likely to be expensive to do so.

What is a business overdraft?

An overdraft is a revolving credit facility that allows you to borrow up to an agreed limit and make draw-downs and repayments as often as you need. Once the preserve of the banks, overdrafts or similar revolving credit facilities are now available from a variety of alternative finance providers.

The amount and cost of credit is negotiable based on your credit rating, the value of any security and the time the facility is needed for.

As with invoice finance, security is normally a debenture over all of the assets of the business and personal guarantees from directors.

Benefits of an overdraft

The main benefit of a business overdraft is its flexibility.

You use the facility when you need it and the amount you borrow at any one time fluctuates in line with your cash flow. In this respect, it should be cheaper than a loan at an equivalent rate, because you will only be paying interest when you are overdrawn.

While designed for covering timing differences between payment and receipts, there is little to stop you using it for almost any purpose once a limit has been agreed. A small equipment purchase, for example, that you expect to be able to repay quickly could be funded through the overdraft.

Fees tend to be reasonable. There is normally an arrangement fee and an annual renewal fee. Fees to cover the cost of putting the security in place might also be applied.

The arrangement will always be confidential between you and your lender.

Things to look out for with a business overdraft

Business overdrafts, particularly through the banks, are not as accessible as they used to be, and can take time to put in place.

Your credit limit will be based on the strength of your balance sheet and could be quite low, reflecting the overall sense of caution amongst lenders when offering facilities of this type. Increases in limits need a separate application and could take more time than you have.  

You could find that your lender prefers to put you on a more structured product like a loan, or directs you towards its invoice finance arm. You need to make sure you are getting the facility that you want.


Overall, if you can secure a business overdraft or revolving credit facility with a sufficient limit, this will normally be the best way to go.

Invoice finance, however, can have very useful applications, particularly in trade finance scenarios or where you are dealing with large customers that force long payment terms on you.

Please talk to us and let us advise you on your business's particular needs and circumstances. We can help you secure the right facility on terms that you fully understand.

Invoice finance or overdraft for working capital?

By: Paul Marston

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