Alternatives to business bank overdrafts

When it comes to SME finance, overdrafts are now a dominant form of core finance. Recent data found that 13% of businesses use a bank business overdraft, a higher figure than any other form of lending, other than business credit cards. 

However, while a business overdraft can offer flexibility, it may come with higher interest rates, fees, and limited borrowing amounts. Fortunately, there are several alternatives to business bank overdrafts that can provide the same financial cushion without the drawbacks.

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How do business overdrafts work?

A business overdraft is a pre-arranged line of credit that allows businesses to withdraw more money than they have in their account. It is typically used to manage short-term cash flow issues, such as covering operational expenses or dealing with delays in payments from customers​​.

The overdraft facility has a set limit agreed upon with the bank, and interest is only charged on the amount used. However, interest rates for business overdrafts are generally higher than other forms of credit, making them expensive if the overdraft isn't repaid quickly​.

Advantages and disadvantages of business overdrafts

Like any form of finance, the advantages and disadvantages of business bank overdrafts depend on how you use them. While they can be an essential support in certain circumstances, in others they can open your business up to extra financial stress and risk.

Advantages:

1. Flexibility: You can withdraw money as needed, and only pay interest on what you use. This is ideal for covering unexpected costs​.
2. Quick access: If your overdraft is pre-approved, the funds are available whenever needed, without a lengthy approval process​.
3. No collateral required: Many business overdrafts, especially for smaller amounts, don’t require you to provide assets as security​. 

Disadvantages:

1. High interest rates: Business overdrafts typically come with higher interest rates than loans, making them costly for long-term use​.
2. Unpredictable costs: Most overdrafts have variable interest rates, which can fluctuate, making it hard to predict borrowing costs​.
3. Repayment pressure: Overdrafts are repayable on demand, meaning the bank can ask for repayment at any time, potentially leaving businesses in financial trouble​.
4. Credit risk: Many business overdrafts will require a personal guarantee, which means a business overdraft can impact your personal credit.
5. Finance limits: given that overdrafts are usually meant as a cash buffer more so than a formal lending solution, financing limits tend to be lower, around £50,000. (Compare the best business overdrafts here to find out more about rates.)

Alternatives to business overdrafts

If you’re looking for a more cost-effective or reliable way to manage your cash flow or invest in growth, there are a wide range of options available.

1. Short-term business loans

For businesses looking for fast access to credit, a short-term business loan can provide financial flexibility for a range of uses. An iwoca Flexi-Loan, for example, can be approved in less than 24hrs, with no lengthy applications or security required. And with our flexible borrowing conditions, businesses can use iwoca credit in a similar way to a business overdraft. 

• Loan amounts: Borrow between £1,000 and £1,000,000, making these loans suitable for everything from short-term cash flow needs to larger investments in growth.
• Flexible repayment terms: While you can set terms from one day to five years, we make it easy to overpay or repay your loan early, so you can control how much interest you pay. 
• Fast funding: With decisions often made within hours, funds can be deposited into your account as quickly as the same day, providing the speed you need to keep up with your business.
• Transparent pricing: iwoca offers clear, upfront pricing with no hidden fees, so businesses know their costs from the outset.
• Only pay for what you need: Draw down from your credit limit as needed and only pay interest on what you use. 

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2. Merchant cash advance (MCA)

A merchant cash advance allows you to borrow against future sales, especially if your business takes a lot of card payments. You receive a lump sum, and repayments are made as a percentage of your future card sales, meaning they fluctuate with your cash flow.

This can ease pressure during slow months, with no fixed repayments to worry about, and the ability to repay faster when business is good. However, it’s also worth being aware that interest rates can be high, especially compared to traditional loans​.

3. Invoice finance

Invoice finance allows businesses to borrow against unpaid invoices, unlocking cash tied up in receivables. There are two main types:

• Invoice factoring: The lender takes control of your sales ledger and collects payments directly from customers.
• Invoice discounting: You retain control of your sales ledger, and the lender advances a percentage of your outstanding invoices​​.

Both options provide quick access to cash without waiting for customer payments, making them particularly beneficial for businesses with substantial outstanding accounts receivable.

4. Business Credit Card

A business credit card provides a revolving line of credit similar to an overdraft, but often with lower interest rates. They are ideal for managing smaller, everyday expenses or covering short-term gaps in cash flow. It’s worth noting, though, that they may have lower credit limits than loans or overdrafts. Also, the interest applies on the entire balance if not repaid in full each month​, so it’s important to stay on top of payments.

5. Asset Finance

Asset finance allows businesses to borrow against physical assets, such as machinery, vehicles, or property. It’s a great option for businesses looking to purchase expensive equipment without upfront costs or leverage existing assets to access capital.

This makes it ideal for large purchases or significant investments since they can be structured as lease agreements, reducing upfront costs​​. However, you also risk losing the asset if you can’t make repayments​.

How to choose the right financing option

Choosing the right financing option depends on your business’s cash flow needs, repayment ability, and the specific situation you’re looking to sort. 

Here are a few considerations:

1. How predictable is your cash flow: If your business has a steady, predictable cash flow, a small business loan with fixed repayments might be the best option. If your income fluctuates, a flexible option like a merchant cash advance or business credit card could work better​​.
2. Amount needed: For larger sums, asset finance or an iwoca Flexi-Loan (up to £1m) might be more appropriate. If you need a smaller amount for a short time, business credit cards or merchant cash advances could suffice​​.
3. Cost sensitivity: If keeping costs low is your priority, avoid high-interest solutions like overdrafts or merchant cash advances. Instead, look into invoice finance or short-term loans​​.
4. Collateral requirements: If you don’t want to risk your assets, unsecured options like business credit cards or an unsecured loan are worth considering, although these often come with higher interest rates​.

Beyond bank business overdrafts

While a business overdraft can offer flexibility, the high interest rates and unpredictable costs make it less suitable for long-term financing and growth planning.  

Before you commit to a product, it’s worth carefully assessing your business’s financial situation and considering the advantages of each option before deciding on the best alternative to a business overdraft. 

To find out why over 120,000 SMEs have chosen iwoca to fund their growth and working capital, why not check out our small business loans calculator?

Sources:

• SME Finance Monitor

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