Business overdraft alternatives: what to use instead

Why overdrafts are disappearing

Many high street banks have quietly reduced their appetite for uncommitted overdraft facilities over the past several years. They are cheap to offer, expensive to monitor, and repayable on demand, which makes them unattractive on a bank's balance sheet compared with asset backed or committed products. The result is that businesses that relied on a flexible overdraft for years often find it cut, capped or withdrawn at the next annual review, sometimes with only a few weeks' notice.

The practical problem is not that the money disappears overnight, it is that the safety net does. An overdraft that sat mostly unused as a buffer against a late payer or a seasonal dip cannot simply be replaced with nothing. Businesses need to plan the replacement before the bank forces the point.

Revolving credit facilities

A revolving credit facility works like an overdraft in that you draw down and repay as needed up to an agreed limit, but it is committed for a fixed term rather than repayable on demand. Pricing is usually a margin over base rate plus a non-utilisation fee on the undrawn portion, so it costs a little more to hold in reserve than an overdraft did, but it cannot be pulled at short notice within the agreed term.

These facilities are typically offered against a mix of receivables, general trading covenant and sometimes a debenture. Businesses with turnover from around £1 million upwards and at least two years of consistent trading are the natural market for this route.

Invoice finance as a structural replacement

For businesses that invoice other businesses on credit terms, invoice finance is usually the closest structural substitute for an overdraft. Instead of a facility sized against the balance sheet as a whole, it is sized against the sales ledger, advancing typically 80% to 90% of approved invoice value as soon as invoices are raised. Because the facility grows with sales, it tends to provide more headroom during growth than a static overdraft ever did.

The trade-off is that it only works for businesses with genuine B2B trade debtors on credit terms. A cash retail or hospitality business cannot use it in this form and needs a different structure.

Merchant cash advance and revenue based finance

For businesses that take card payments, a merchant cash advance provides a lump sum repaid as a fixed percentage of daily card takings, which flexes automatically with trading volume. It is quick to arrange, usually within a week, and does not require the credit control infrastructure an invoice facility needs, but the cost of funds is generally higher than a bank facility and is best used for short, self liquidating needs rather than as permanent working capital.

Revenue based finance products work on a similar principle for businesses with recurring or subscription income, repaying as a percentage of monthly revenue rather than card takings specifically.

Building the right combination

Most businesses replacing an overdraft end up with a combination rather than a single like-for-like swap: a revolving facility or invoice line for day to day working capital, and a shorter, more expensive facility such as a merchant cash advance held in reserve for genuine peaks. The mistake to avoid is waiting until the overdraft is actually withdrawn before starting the search, because replacement facilities of this kind take weeks to arrange properly and cannot be rushed through in the days after a bank's letter arrives.