Invoice Factoring Vs. Bank Overdraft—Which Is Best for Your Business?

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Compare the Two Forms of Business Funding to Decide Which Best Suits Your Needs

It is always best to look at all the options when deciding what type of finance will be a good fit for your business. And, when you need a line of credit to boost a company’s working capital, there are various ways to meet that need.

Of course, you could seek an investment in the company to boost working capital. But that would entail a potential dilution of ownership for existing investors. An alternative for relatively small amounts would be to use business credit cards. But maintaining a significant balance on a credit card can be costly.

Other options for working capital funding include a bank overdraft facility or sales invoice financing. Both these options provide flexible credit lines with no regular fixed repayment. But how do you decide which of these two finance products will be best for your business? Here are a few things to consider when deciding between an overdraft facility and sales invoice factoring.

How Do Overdraft Facilities Work?

A bank account is overdrawn when you draw out more money than you have available. But, if you have an agreed bank overdraft facility, you can overdraw your bank account up to a specified limit.

When a bank account is overdrawn but stays with the agreed limit, the bank will charge interest on the overdrawn amount. Higher interest rates will be applied if an overdraft limit is exceeded, or the bank may refuse to honor payments.

Overdraft facilities are designed to be used as a safety net for periods when cash flow is tight. However, the interest rates on overdrafts are usually much higher than on fixed-term loans. A fixed repayment loan would probably be better if you need funding for a long-term project or to purchase capital equipment.

Related: Factoring or Term Loan—Which is Best for Your Business?

How Does Invoice Factoring Work?

In an invoice factoring arrangement, the factoring company buys your sales invoices from you at a discounted rate. The factoring company will usually advance a high percentage—from 80 to 95 percent—of every invoice within 24-48 hours of the invoice being sent to your customer.

Factoring companies charge a financing fee, which is deducted from the funds advanced. There may also be some additional costs, such as credit-check and processing fees.

Invoice Factoring and Overdraft Facilities Compared

Sales invoice factoring and bank overdraft facilities both provide flexible financing for businesses. However, there are some significant differences between the two to bear in mind. Here are the most critical points to consider when comparing overdrafts with factoring.

1. Accessibility

The lending criteria for an overdraft facility are much the same as for a fixed repayment loan. For example, a bank will probably want to see copies of accounts. And a bank will check the credit score of a business before extending an overdraft facility.

The requirements for a factoring arrangement are less stringent. A business will, of course, need to have sales invoices suitable for financing. And a company’s customers must be reputable and creditworthy.

Customers’ creditworthiness is far more critical than that of the business applying for a factoring account. So, factoring is more accessible for small and new businesses than an overdraft facility. And companies with low credit scores can also apply for an invoice factoring account.

2. Impact on Business Credit Score

A bank overdraft facility is a conventional line of credit. When the bank account is overdrawn, the balance will be a current liability in the company accounts. So, bank overdraft facilities affect a company’s credit rating and could hinder the ability to obtain further credit.

A factoring company buys sales invoices from its customers. So, the funds received are not a loan in the strictest sense and do not appear as a liability in the balance sheet. So, invoice factoring does not negatively affect the liquidity of a business and does not usually impact the credit score.

3. How Much Can Be Borrowed?

The amount that can be borrowed on an overdraft facility will depend on the business’s credit score. A bank will also consider the size of the business, the financial accounts, and how well the company bank account has been operated. Based on these criteria, the bank will offer an overdraft limit within which the company must remain.

A factoring company will advance as much as 95% of the value of all sales invoices within 24-48 hours. The maximum amount that can be borrowed equates to the total value of accounts receivable. So, as the business grows, the funding increases.

4. Collateral

In most cases, the only collateral required for invoice factoring is the sales invoice. When an invoice is factored, the rights to the proceeds of that invoice are assigned to the factoring company. And then, your customer pays the factoring company rather than your business.

Commercial overdraft facilities, on the other hand, usually require collateral. The collateral requirements might be an asset of the company, a personal guarantee, or both.

5. Cost

The cost of both invoice factoring and overdraft facilities varies. However, overall, factoring is likely to cost slightly more than a bank overdraft facility. The reason for this difference is that a factoring company will be providing more than strictly finance. A factoring service also includes account receivables management services, such as credit checking customers and collection of unpaid sales invoices. However, they also represent a cost savings for a business in terms of resources no longer needed for AR management and collections.

Related: The Pros and Cons of Invoice Factoring for an Expanding Business

6. Flexibility

Overdrafts are flexible because, up to an agreed limit, you only borrow what you need. And there are no fixed repayments due on an overdraft. However, should you need to increase an overdraft limit, you must negotiate with your bank. And any increase will be subject to the business credit score and other bank lending criteria.

Invoice factoring financing grows and contracts with the value of your sales invoicing. As a result, one of the most significant advantages of factoring is flexibility. When you use a factoring service, as your business expands, your factoring finance facility also expands.

7. Reliability

So long as you operate within the terms of the agreement, a factoring account will continue until you decide to terminate the arrangement. However, a bank can withdraw an overdraft facility if they are concerned about your company’s ability to repay the overdraft.

Related: Is Invoice Factoring Right for Your Business?

The Bottom Line

To sum up, if you are only looking for short-term finance, a bank overdraft facility may be the best option. But an overdraft facility will be subject to the bank’s stringent lending criteria, and it could affect your business’s ability to get credit elsewhere. And increasing an overdraft limit means reapplying for additional credit with the bank.

However, if you want a longer-term boost to working capital, invoice factoring might be the answer. Factoring flexes with the business turnover. And factoring is generally more accessible to small and newer businesses. However, factoring may be slightly more expensive than an overdraft because of the accounts receivable management and collections functions included in the service.

Your Questions Answered Quickly

Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.

About Universal Funding

Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.