How a business overdraft works
A bank overdraft is a pre-agreed credit line attached to your business current account. You can draw funds up to your overdraft limit and repay them as cash comes in. Interest is charged only on the outstanding balance, typically at a rate set above the bank's base rate.
Overdrafts are flexible and simple, but they come with limitations. The limit is fixed and set by the bank based on your creditworthiness and relationship. It does not automatically increase as your turnover grows. Overdrafts are also typically reviewed annually and can be withdrawn at short notice.
Why invoice finance scales better
Invoice finance is secured against your actual unpaid invoices. As your turnover grows, your sales ledger grows, and so does your available facility. A business that doubles its turnover will roughly double its available invoice finance facility without needing to renegotiate with a lender.
This scalability makes invoice finance significantly more appropriate than an overdraft for growing businesses, where working capital requirements increase rapidly with turnover.
Cost comparison
Overdraft interest rates for SME businesses typically range from 3% to 8% above base rate, often without a service charge. Invoice finance has both a service charge and a discount rate, making a direct comparison less straightforward. For smaller drawings, an overdraft may be cheaper. For businesses consistently using a large facility, the comparison depends on the specific pricing offered.
Accessibility
Bank overdrafts have become progressively harder to obtain for SME businesses without a long banking relationship and strong balance sheet. Invoice finance lenders assess primarily the quality of your sales ledger and the creditworthiness of your customers, making it accessible to a wider range of businesses.
Frequently Asked Questions
Can I have both an overdraft and invoice finance?
Yes, though your bank may want to understand the invoice finance arrangement when considering your overall credit exposure. Many businesses use invoice finance as the primary working capital facility and maintain a smaller overdraft as a buffer.
Will switching to invoice finance affect my banking relationship?
Invoice finance providers take a fixed charge over your sales ledger as security. Your bank may require notification of this charge and it may affect your ability to use the same ledger as security for other bank facilities.