Two popular working capital solutions work very differently; which one suits you depends mainly on the structure of your debtor book.
Running short of working capital is one of the most common financing challenges for growing businesses. Two solutions regularly come up: factoring and an overdraft facility. Both give you headroom to cover purchasing, wages, and running costs while waiting for customer payments, but they function fundamentally differently.
Which of the two suits your business depends less on personal preference and more on the structure of your debtor book: how many customers you have, the size of the invoices, and how predictable their payment behaviour is. This article provides a practical decision framework.
How an overdraft facility works
An overdraft facility is a flexible credit limit on your business bank account. You draw down funds as needed, up to an agreed limit, and only pay interest on the amount drawn. The bank bases the limit on your turnover, balance sheet, and often a combination of security such as inventory and general debtors.
The main advantage is flexibility: you can draw down and repay without separate administration per invoice. The downside is that the limit is fixed based on a periodic review and therefore does not grow automatically with a sudden spike in turnover.
How factoring works
With factoring, you sell your outstanding invoices to a factoring company, which pays out a large percentage of the invoice value directly to you, often within a day. Once your customer pays, the factoring company settles the remainder, deducting their fees.
Factoring grows automatically with your turnover: the more you invoice, the more financing you obtain. This makes it attractive for fast-growing businesses. The drawback is that costs are calculated per invoice sold, which can make it relatively expensive on slim margins, and in some arrangements, your customer will be notified.
Decision framework based on your debtor book
The structure of your debtor book is the key factor. If you have many customers with relatively small, spread-out invoices and solid creditworthiness, factoring is often straightforward to implement and releases liquidity directly in proportion to your turnover.
If you have a limited number of large customers—for instance, as a supplier with two or three major OEMs as clients—customer concentration is an area of concern: if one large customer delays payment, it directly hits your factoring capacity. In that case, an overdraft facility, potentially supplemented by dedicated debtor finance, may be more stable.
- Many customers, small invoices, good spread: factoring often works well
- Few customers, high concentration: consider an overdraft or hybrid solution
- Highly seasonal turnover: factoring grows automatically
- Predictable, stable turnover: overdraft is often cheaper
- Rapid growth with mounting debtors: factoring eases cash flow immediately
Worked example: comparing the liquidity impact
Suppose you have €100,000 in outstanding invoices each month with an average payment term of 60 days. With factoring, you typically receive a large proportion—say, 85% to 90% of the invoice value—within a few days, making around €85,000 to €90,000 available immediately rather than waiting 60 days.
With an overdraft facility of, say, €75,000, you can bridge part of that same period, but the limit does not rise automatically as your turnover grows. In both cases, calculate the costs: a percentage fee per invoice with factoring, and interest on the drawn balance with an overdraft, and weigh that against the value of having earlier liquidity for your business.
Combining both is also possible
Many businesses in the manufacturing sector around Eindhoven combine both options: an overdraft facility for day-to-day flexibility and factoring specifically for larger or slower-paying invoices. This requires slightly more administration, but gives you the best of both worlds without being reliant on a single type of finance.
Discuss with your lender or bank whether a combination is possible without security being pledged twice, as this can be a point of discussion between banks and factoring companies.
What to do next
First, map out your debtor book: number of customers, average invoice value, payment terms, and customer concentration. Use this overview to determine whether factoring, an overdraft, or a combination fits best, and request quotes from at least two providers. For more detail, see our pages on factoring and working capital, or model your figures with the finance calculator.
Frequently asked questions
- Is factoring more expensive than an overdraft facility?
- That depends on your margins and payment terms. Factoring charges fees per invoice, while an overdraft charges interest on the drawn amount; on slim margins, factoring can weigh relatively heavily, but it also releases cash more quickly.
- Can I use factoring and an overdraft facility at the same time?
- Yes, many businesses combine both. However, ensure that security is not pledged twice to both the bank and the factoring company, and discuss this in advance with both parties.
- What if I only have two or three major clients?
- With heavy customer concentration, factoring is riskier because your borrowing capacity depends heavily on the payment behaviour of those clients. An overdraft facility or a hybrid solution is often more stable in that scenario.