It is highly likely that at some point in your business lifecycle you will approach your bank for additional funds, most likely an overdraft.
An overdraft can be more straight-forward than a loan, due to less paperwork once the facility is established.
An overdraft can also occur if your spending has inadvertently exceeded your available funds, you don’t want this to happen, as it could affect your credit rating.
You can establish an overdraft facility with your bank for those occasions when you do need extra cash flow. There is usually a maximum amount against one of your accounts and interest is charged on the extended amount. Fees are charged for setting up the facility and if you ever need to reapply, more charges will be incurred.
This facility can also be cancelled without notice if the lender believes you may default on the amount owed and all money must be paid back together with accrued interest. If assets form security against default, if you default, your assets then are at risk.
You are locked in to your existing bank for an overdraft as well, so there isn’t flexibility to shop around.
With an overdraft you could often be in the “red”, not the best colour on your bank statement.
Factoring is not an overdraft or a loan and usually no form of collateral such as assets enter into the equation. Your invoices are the collateral and this is what you are paid against.
With factoring you are paid a percentage of the invoice amount up front, with a further percentage paid when the invoice is paid in full.
Once a Factor has approved your initial application, funds are available in a short time, around 48 hours from the invoices being presented and there isn’t a debt.
Factoring is more flexible than an overdraft, as your business grows, it is linked to the amount of business you have and terms can be more favourable as your business increases.
An overdraft is usually granted based on your past financial performance, i.e. it is historical, factoring is about the present and about the future. Cash is available on your current sales and receivables. If your financial history is poor, you can forget about an overdraft as most lenders these days are far more risk averse. This also applies if you are a start-up business without historical financials to put forward, you may not even get your toe in the door.
While an overdraft could be cheaper in dollar terms, you need to consider the time and effort needed to secure it in the first place and the need to do it all over again, once the fixed term has expired.
Invoice Factoring is paid for in your increased sales, achievable because you have a regular cash flow to purchase more inventory to increase your production and maintain satisfied customers.