For a long time, business overdrafts were the most popular way of managing short-term cash flow. You’d have an overdraft attached to your business bank account, and if you needed some extra cash you could simply overdraw your account for a few days or weeks until things evened out again.
These days, it’s often not so simple. The banks don’t offer overdrafts as much as they used to — our research showed that small business overdrafts are being consistently reduced or removed — and in this context you might not want to rely on one even if you can get it, knowing that the bank can call it in at any time.
The alternative finance market has a few other options, so let’s take a look at the best alternatives to a business overdraft that you can use to manage your cash flow.
Revolving credit facilities
The closest equivalents to overdrafts are collectively known as ‘revolving credit’. Like overdrafts, they’re characterised by a pre-agreed limit that you can draw whenever you like. The main difference is that a credit facility isn’t usually attached to your bank account — you’ll log in to an online portal and choose how much to draw from your limit.
Aside from initial setup fees, with many of these facilities you only pay for what you use, which means the facility can sit unused until you need it. Overall, revolving credit facilities feel quite similar to business overdrafts, and they’re a useful safety net to have in place.
Merchant cash advances
If your business uses a card machine to take payment from customers, you could be eligible for a merchant cash advance. Like overdrafts and revolving credit facilities, you’ll have a pre-agreed borrowing limit, but it’s based on your card sales specifically.
Usually your limit will be the equivalent of 1 month’s average sales, so a key part of the application process is giving the lender access to your card terminal data.
Perhaps the best part of merchant cash advances is that because the lender works with your card terminal provider, you repay automatically as a percentage of sales.
For example, if your agreement specified an 80/20 split, a sales transaction of £100 would automatically repay £20 to the lender and transfer the other £80 to your bank account as normal.
Because each individual transaction is broken down this way, repayments go up and down with your takings — which might be a better arrangement for your business than the fixed monthly payments that often come with standard loans. The main downside is that merchant cash advances tend to be quite expensive.
If you invoice your customers, you could use the outstanding invoices to raise cash flow finance. There are a few different kinds of invoice finance which are suitable for different business sizes and sectors, but the general idea is that the lender gives you an advance based on the value of outstanding invoices. Then, when your customer pays, you get the remainder minus a small fee.
For example, if your facility had an advance rate of 85 per cent and you raised an invoice worth £10,000, you’d get an advance of £8,500 from the lender, then the remaining £1,500 minus fees once your customer had paid. The fees vary, but would usually come in around the 1–3 per cent mark, so you’d pay the lender between £100 and £300 in this example. There is usually a fixed service fee too, which is applied monthly.
Like overdrafts, invoice finance facilities have an upper limit, which means you know how much you could access if you need it. If your cash flow requirements fluctuate a lot, you could also use one of the ad-hoc or selective products, where you get an advance on some invoices but handle the others as normal.
Although business overdrafts are a useful thing to have in place, it’s clear that they’re not your only option. If you can’t get an overdraft or your existing facility is taken away, some of these alternatives might work well for your business — and they could be faster to set up than a bank overdraft too.
Conrad Ford is chief executive of Funding Options.