Reports indicate that nearly 60% of small and medium sized enterprises (SMEs) encounter challenges related to cash flow. This leads to difficulties in managing regular payments and operational expenses, ultimately leaving them in a state of financial instability. In an ongoing blog series, we are delving into various financing alternatives available to businesses and comparing them to the B2B Buy Now, Pay Later (BNPL) option. In this final instalment, we explore business overdraft facilities.
A business overdraft is a financial arrangement offered by a bank or financial institution to business account holders. Just like an overdraft that you’d use in your personal life, it allows businesses to withdraw or spend more money with their bank account than they have in their balance, essentially creating a negative balance, up to a predetermined limit. This overdraft limit is typically agreed upon in advance and is based on the business's creditworthiness and financial history. A business overdraft can serve as a valuable financial tool to help businesses manage their cash flow fluctuations and maintain liquidity during challenging times.
B2B BNPL also helps businesses to manage and mitigate cash flow issues by enabling buyers to access payment terms while sellers get paid upfront and in full. This means that both parties in a transaction are able to protect their working capital and pay (or get paid) at the most convenient time.
Please be aware that while this guide is intended to be helpful, it is not financial advice.
B2B BNPL vs overdrafts: an overview
The table below shows an overview of how B2B Buy Now, Pay Later stacks up against an overdraft facility from the bank.
Let’s dive in and learn more about overdrafts and B2B Buy Now, Pay Later.
What is a business overdraft?
An overdraft facility is an agreement that businesses can spend more than they have in their business account, up to a certain, pre-agreed limit. The limit is tailored to the business and usually depends on the size of the revenue. SMEs in the UK can usually access up to £50,000, for a fee.
Business overdrafts are often used to address short-term cash flow gaps or unexpected expenses. They provide flexibility for businesses to access additional funds when needed without having to apply for a traditional loan. Interest is charged on the overdrawn amount, and businesses are not often required to repay the overdraft within a specified period. However, the bank can demand repayment at any time.
What are the advantages of a business overdraft?
There are several key benefits that make overdrafts a popular form of B2B financing.
1. It’s a simple way to get funds
Overdraft facilities are usually simple to arrange. You may be able to request an overdraft straight from your banking app or you might even be offered one when you open the account.
2. Changing how much you can borrow is easy
Increasing or decreasing the limit of your business overdraft is usually a straightforward process, which means you can access more funds when needed and limit your debt when cash is flowing healthily. You may need to pay an arrangement fee.
3. Stick to your financial commitments
Having an overdraft means that direct debits, standing orders or other payments can still go ahead even if your business does not quite have enough money. This can be very useful for tax plans, where missed payments are penalised or it could be invaluable for paying employees on time each month.
4. Cheaper fees than other financing options
Overdraft fees are usually cheaper than those associated with business loans, revolving credit or credit cards.
5. Interest is only paid on how much you use
Businesses are typically only charged interest on the amount they overdraw from their account, and only for the period that the overdraft is used. This can be more cost-effective than taking out a fixed loan with interest on the entire loan amount.
6. No fixed repayment schedule
Business overdrafts do not typically have fixed repayment schedules. As long as the business stays within the agreed-upon overdraft limit, they can repay the overdraft at their own pace, making it suitable for managing irregular income patterns.
What are the disadvantages of a business overdraft?
As with all things, there are some drawbacks to be aware of when considering opting for a business overdraft.
1. Costs can add up and lead to debt
Interest is usually calculated on a daily basis, so costs can quickly grow if the overdraft is not topped-up. Also, if you max-out your limit, the fees become much more expensive. These factors put businesses at risk of building up excessive debt.
2. The risk of over-reliance
Some businesses can come to rely too heavily on their overdraft and find it hard to climb out again. Businesses may become vulnerable if they consistently rely on overdrafts to cover operating expenses, as it does not address underlying financial issues.
3. Overdrafts should be used sparingly
Overdrafts tend to be short-term solutions and may not be the best choice for long-term funding needs.
4. Uncertain repayments
Yes, we know we put this in the advantages list too, but lack of a fixed repayment schedule can lead to uncertainty about when and how the borrowed amount will be repaid. This can make it challenging for businesses to manage their debt effectively.
What type of business could benefit from an overdraft?
Some businesses are well suited to the features of an overdraft. They include:
- Firms with regular HMRC payment plans, standing orders or direct debits.
- Businesses that occasionally need small amounts of money that they can pay back quickly.
What type of business is not a good match?
Conversely, there are firms who may not reap the full benefits of an overdraft facility. This includes:
- Firms that do not yet have revenue could struggle to climb out of their overdraft.
- Seasonal firms – for example, skiing resorts or beachside hotels– that may spend months in their overdraft as they could suffer from daily interest rates.
What is B2B BNPL?
Unless you’ve been living under a rock, you've likely encountered the concept of Buy Now, Pay Later (BNPL) when shopping online. Customers are given the option to postpone payment for 30 days or split their purchase into several monthly instalments. Providers such as Klarna, Clearpay, and even firms like Apple now offer this service, allowing buyers to defer payment while sellers receive the full amount upfront, minus a small fee.
Although BNPL has gained popularity recently, it's not exactly a new payment method. Retailers of big ticket consumer items like furniture and kitchen appliances have provided similar services for years. Likewise, B2B trade has relied on trade credit for decades, which follows the same principle of deferring payment. What's new is the technology facilitating BNPL, part of the broader trend known as "embedded finance," which has been revolutionary for digital marketplaces and e-commerce sellers.
Now, BNPL is making its way into the B2B world. With a simple click at the checkout, buyers can secure their preferred terms while sellers receive immediate payment. It operates in a manner akin to invoice factoring, but with greater speed.
What are the advantages of B2B BNPL?
Some of the key benefits of B2B Buy Now, Pay Later include:
1. Upfront payment
Sellers receive payment upon the delivery of goods, significantly improving cash flow and enabling them to focus on growth goals.
2. Full payment guaranteed
With solutions like Hokodo's, suppliers receive the full invoice amount, even if the buyer defaults.
3. Enhanced payment terms
BNPL solutions empower sellers to offer more favourable payment terms to buyers, resulting in improved conversions and customer loyalty.
4. Time and resource savings
B2B BNPL consolidates the entire trade credit management process, saving time and resources related to fraud checks, credit scoring, financing, insurance, payment processing, and collections.
5. Seamless integrations
BNPL platforms offer plugins and integrations for easy onboarding, providing buyers with a smooth checkout experience without sellers having to deal with administrative tasks like selling invoices to a factor.
6. Risk management
B2B BNPL providers assume responsibility for credit and fraud risks, offering protection to sellers.
7. No collateral required
Unlike traditional loans, B2B BNPL typically doesn't require collateral or security for access.
What are the disadvantages of B2B BNPL?
On the flip side, there are a few potential disadvantages to consider:
1. Not suitable for all sellers
Businesses without an online checkout or those whose buyers prefer traditional invoices may find B2B BNPL less suitable.
2. Third-party involvement
B2B BNPL providers handle payment collection and buyer communication, which can potentially affect the business relationship if not managed properly.
3. Fees
Like other financing options, B2B BNPL comes with costs that vary among providers. For instance, Hokodo charges a small percentage of each BNPL transaction.
What type of business could benefit from B2B BNPL?
B2B BNPL can benefit various types of businesses, including:
- E-commerce websites, marketplaces, or online platforms where suppliers sell their products.
- Businesses with both online and offline sales, seeking to streamline payment processes across channels.
- Companies aiming to offer trade credit in an online environment.
- Businesses that need prompt invoice payments for cash flow and want to provide competitive payment terms to buyers.
For example, Manchester-based wholesaler Shonn Brothers has experienced the advantages of B2B BNPL.
“Hokodo has provided an innovative and revolutionary experience for our wholesale and trade customers giving them the opportunity to Buy Now, Pay Later,” explains Daniel Shonn, Director. “It is an interesting proposition with great sales potential.”
What type of business is not a good match?
There are a few scenarios where B2B BNPL might not be suitable, including:
- Businesses lacking an online presence and unable to adopt digital solutions for offline transactions.
- Businesses offering customised services requiring manual invoicing.
Business overdraft vs B2B BNPL: which is right for you?
If you operate as a B2B merchant or manage a marketplace, whether your sales are conducted online or offline, consider exploring BNPL as it could be a favourable choice for both you and your customers. With BNPL, you receive immediate payment and gain protection against potential fraud and credit risks, while your customers enjoy the flexibility to postpone payment to a more suitable time. It's important to feel comfortable with the lender, as they will be directly engaging with your clients.
If you rely on direct debits or standing orders, having an overdraft facility could be useful. And remember, you don’t just have to choose one! Many businesses have an overdraft and also take advantage of B2B Buy Now, Pay Later.
Download our ultimate guide to learn more about your options when it comes to B2B financing.
