Whether you’re a sole proprietor or small business, there will come a time when you need a financial boost. Many businesses turn to loans or a line of credit in the form of an overdraft to receive funding before considering alternative options such as invoice factoring.
What is an overdraft facility?
An overdraft is an extension of credit, that occurs when you try to withdraw more money from your account than what you have available. It allows an owner to continue withdrawing money even when the account balance has reached zero and covers payments that would otherwise be rejected. This includes transactions, withdrawals, and cheques.
Overdraft facilities bear interest and typically charge a fee per overdraft. If you exceed the overdraft facility limit, your bank may also charge you more interest or refuse the withdrawals altogether. Not paying back your overdraft can result in the bank turning your account over to a collection agency which can negatively impact your credit score.
What causes an overdraft?
An overdraft can happen for many reasons. If you have to pay for expenses, repairs, fuel, or meet payroll, an overdraft can provide you with funds to cover those costs. Most banks provide overdraft facilities for their account holders, which means many business owners turn to overdraft facilities as a cashflow solution.
What impact does a bank overdraft have on my finances?
While it might seem like a decent arrangement to have an overdraft facility with your bank should you need immediate funds, consider the following:
Need for collateral
Most overdraft facilities require you to have your loan secured against business assets, typically in the form of a lien on your business assets.
Limitations on overdraft
Overdraft facilities are usually relatively small and don’t grow with your company. If your monthly expenses continue to increase in line with your growth, your overdraft facility may not be enough to support you.
Excessive fees
Overdraft facilities often come with a heap of other fees like an arrangement fee to extend your overdraft or an extra charge if you exceed your overdraft limit.
What are some good alternatives to overdraft facilities?
Invoice factoring has been around for decades and is one of the most reliable and efficient ways to receive immediate cash flow. It works by selling your outstanding invoices for upfront capital.
The factor provides you with an upfront payment of up to 98% of the invoice value and then follows up with your customer to collect the payment. Once the invoice is paid, you’re given any leftover holdback minus the fees for their service. This boosts your company’s cash flow without being indebted to your bank.
The differences between factoring and overdraft
While both factoring and overdraft facilities provide your business with finance management that is flexible, there are some key differences between the two options.
Accessibility
Since the requirements for overdraft facilities are often demanding, it can be challenging to qualify. Banks will check your business’s credit score, size of your business, length in business, financial statements, and other criteria. Additionally, they might also ask you to provide proof of personal financial investments, and a detailed business plan, and often require that your business is generating a positive revenue for at least 12 months.
Factoring offers a much simpler process. You generally only need to present your business license, insurance, and corporate tax returns but this can vary among factoring companies. Additionally, you can be approved within days and even receive same day funding should you need it. Banks can take weeks to review all your documents before they approve your overdraft facility making it much less accessible to businesses.
Credit score
Remember that overdraft facilities are a line of credit. By utilizing them, you can drastically impact your company’s credit score.
Since a factoring company is buying the invoices from you, it doesn’t affect your credit. Instead, it’s a simple transaction between you and the factoring company.
Fees
As with all loans and lines of credit, there are fees. Overdraft facilities will often charge you a number of fees including, but not limited to:
Overdraft fee
Occurs every time you make a transaction.
NSF fee
Occurs when the bank rejects a transaction that exceeds your overdraft limit.
Overdraft protection fee
Occurs every time the bank arranges a transfer from one of your accounts to pay for the overdraft.
Extended overdraft fee
Occurs when your account balance remains in the negatives for a certain period of time.
There can be additional fees that you can be charged for dependent on the lender and the type of overdraft account you have set up. You will also have to pay interest on your overdraft.
Factoring fees are much fewer and more transparent than overdraft fees. They include:
Origination fee
Usually a 1% fee is paid prior to the activation of the factoring agreement. Some factors don’t charge this fee at all.
Factoring fee
Paid on the face value of your invoices. These generally range from 1% – 3% flat.
Funding fee
Nominal fees are charged for every invoice or batch that is processed. Some factors don’t charge this fee at all.
Termination fee
This fee only occurs if you terminate your agreement prematurely. Some factors don’t charge this fee at all.
Factoring companies also provide you with more than just funding. They manage your accounts receivables and even monitor your customers’ credit for you. These benefits save you precious time when running your business, something that overdraft facilities simply don’t provide.
Boost your cash flow with factoring
Regardless of why you might need a cashflow boost, working with a factoring company can be a vital partnership for your business. Without the need for collateral and a simple approval process, factoring can be an ideal alternative to overdraft facilities.
Waiting on your bank to raise your overdraft limit or pay off accrued interest from your last withdrawal can set you back financially. You’ll be missing out on funding that could help your business grow or steadily maintain its operations. Allow yourself to focus on your business and gain the competitive edge you need to succeed in your industry.
If you want to improve the cash flow of your business, consider invoice factoring today.
FAQ
Make sure you understand the terms and conditions of your accounts with your lenders clearly, as some have overdraft facilities set up for you when you first activate your account. You can also seek out other funding sources that help to increase cashflow, like invoice factoring
Both overdraft facilities and factoring companies provide business owners with immediate capital. Consider the fees associated with each service and choose an option that doesn’t leave you guessing how much you will be paying in fees or interest. Keep in mind that factoring often charges fewer fees, no interest, and no collateral which makes factoring a great solution that keeps cash flowing.
Overdraft fees vary by banks since every credit union has its own limit of overdraft fees charged in one day. Some only charge an initial overdraft fee whereas others charge fees every day or every five days.
Sign up for a FreightWaves e-newsletter to stay informed of all news and trends impacting supply chain careers and operations.
