Cash tied up in unpaid invoices, with upcoming payroll and other business costs pending, can be frustrating and destabilising for many SMEs.

With 41.8 per cent of SMEs experiencing late payments, according to an OECD 2024 report, credit facilities can help bridge gaps in working capital.

For businesses that need a quick cash injection, invoice financing and overdrafts serve similar purposes, but are suited to different circumstances.

What is invoice financing?

Invoice financing works by a lender using unpaid invoices as collateral for funding.

Lenders can advance up to 95 per cent of an invoice’s total value almost immediately, instead of waiting 30 days, 60 days or longer for payment.

While the remaining balance of an invoice’s value will be available when the client pays, lenders will deduct a service charge and discount depending on the value of the loan.

Invoice financing doesn’t add to existing debt, which is ideal for SMEs that can’t or don’t want to borrow more.

However, if you have narrow margins, you might not be able to use these services, as the fee structures can sometimes dent profitability.

Likewise, a small volume of invoices that are high value could lead to disproportionately high costs for advancing payments.

Where this is the case, it may be worth considering a business overdraft.

What are overdrafts?

An overdraft is a pre-arranged credit facility linked to a business bank account, which allows you to spend more than your available balance, up to an agreed limit.

Where an overdraft is used and a balance turns negative, you will be charged interest on the amount borrowed.

Interest rates for UK businesses typically range from the Bank of England base rate plus two to four per cent, up to 15 per cent or more, depending on demand and the lender.

Overdrafts are often relatively straightforward, as you draw funds when needed and it costs you nothing when unused, without any per-invoice admin.

However, banks can reduce or withdraw borrowing limits based on demand, sometimes at very short notice.

Limits are set based on your business’s financial health and relationship with the bank, with established relationships receiving more favourable borrowing costs and higher credit ceilings.

Which is right for your business?

Both credit facilities can provide the short term cash needed to keep your business running smoothly, but each has different uses and criteria.

Invoice financing could be the better fit if:

  • There is a recurring and growing cash flow gap which is caused by late paying customers
  • You’ve maxed your overdraft limit or are likely to do so in the future
  • You’re finding yourself spending a lot of time chasing payments
  • Your business is growing and new contracts are widening the cash flow gap

You may want to consider an overdraft if:

  • Your shortfall is occasional and you don’t often have to rely on credit
  • You want a borrowing option that only charges when you use it
  • You sell directly to consumers or take payments immediately after a sale, so there are no invoices to finance

While each form of borrowing has its own unique applications, they aren’t mutually exclusive.

Invoice financing may cover the predictable gap caused by late paying customers, while an overdraft acts as the stopgap to cover any unexpected cash emergencies.

Seeking advice from an accountant can help ensure your credit facilities are structured correctly, so you can meet liabilities and avoid paying unnecessary fees.

Speak to an accountant

Our accountants can forecast your cash flow to determine if shortfalls are recurring or occasional, advising whether an overdraft or invoice financing is the smarter choice.

Where cash flow gaps have been identified, we can help address structural problems and offer other solutions that can help reduce your reliance on borrowing.

Weighing up invoice financing and an overdraft? Contact our experts before approaching a lender.