Alternatives to a Business Overdraft
Over the last two decades we have seen banks move away from business overdrafts. There are a couple of reasons for this that we can look at later, but more importantly let’s discuss what the alternatives to an overdraft are.
There are several alternatives but the most suitable alternative will depend upon what you actually want the funding for. In our opinion overdrafts should be used as revolving facilities where borrowing increases as you pay wages and suppliers and decreases as you receive payments from customers. However, over the years we have seen businesses use overdrafts to purcase new machinery and also as a deposit on commercial mortgages.
Invoice Finance – this can be in the form of invoice discounting, invoice factoring or perhaps some hybrid product. In effect you are smoothing your cash flow by borrowing against your invoices that are yet to be paid by your customers. Lenders will advance up to 100% of the gross invoice value to you the day after the invoice is raised. As true revolving facilities, invoice finance facilities are very similar to a business overdraft, especially as most overdrafts had a debtor covenant anyway. The advantage of an invoice finance facility is that they grow in line with your sales. Disadvantages include the cost as they are more expensive than an overdraft and the fact they are only available to businesses that sell to other businesses so typically they are not suitable for retailers or hospitality businesses.
Trade/Purchase/Stock Finance – these three products are different but also very similar hence we have grouped them together. They allow you to access cash to pay suppliers. They can be very useful for importers and wholesalers depending on when in your trade cycle you need to access cash. To understand more about these options it is worth looking at our guide – How To Finance Supplier Payments. This explains where in your trade cycle you can access these types of funding.
Merchant Cash Advances – This is where you are borrowing against anticipated credit card takings. For businesses like shops, hotels and restaurants receiving lots of card payments, merchant cash advances are an incredibly flexible way to raise money. The best thing is that you pay back the loan as a percentage of your turnover, and overpayments can also be agreed at short notice to cover unexpected bills.
Asset Finance – if you are looking at a capital expenditure it really makes sense to use asset finance. You are utilising the value of the new asset as security and spreading the cost of the purchase over the useful life of the asset. This can take the form of hire purchase, finance lease or operating lease. Each has it’s own benefit depending on how you want to treat VAT and what is important in terms of your balance sheet.
Asset Refinance – this is obviously similar to asset finance but here you are refinancing assets that are already owned by the business. This can be to reduce the current monthly outgoings or can be to raise additional cash to inject into the business.
Business Loans – there are a variety of short to medium loan options out there at present. Some are secured loans and others are unsecured loans. In most cases the unsecured loans still require directors guarantees. The rates range from circa 6% to 80% apr with terms typically from 6 months to 5 years. Remember a loan will inject cash into your business but if you are using it to aid cash flow remember that you will then have an additional monthly repayment to service. You also have the full amount outstanding all the time when comparing to a revolving facility so interest costs are likely to be higher which will reduce profits. These loans are however a very good option for some businesses.
Why Do Banks Not Provide Business Overdrafts?
The reality is that they do but not like they used to and one of the main reasons is what many call the Brumark case. In essence the courts ruled in this case and in the case of Spectrum Plus v Natwest that a debenture is only a floating charge over book debts and not a fixed charge. This had huge security implications for banks where they were reliant on the debtors of a company for security. It was ruled that a fixed charge could only be achieved with the debtors paying into a totally seperate account. As such invoice finance was the preferred route of lending by banks in these instances.
How Funding Solutions Can Help
No matter what funding issue you are facing as a business owner we are pretty sure we will have seen it before. All we do all day, every day is look at funding options for our clients. We know the business finance market inside out and know where funding is available and what pitfalls to look out for. If you have any funding requirement for your business get in touch on 0845 251 4040 or firstname.lastname@example.org