Cash flow has always been the silent killer of small firms, but higher rates, patchier demand and slower payments have made it a daily fight. Many SMEs have discovered that the bank overdraft they relied on either shrank, got repriced, or came with covenants that don’t match how modern trading works. That’s why alternative finance for SMEs has moved from ‘nice to have’ to part of the standard liquidity toolkit. The sensible approach isn’t chasing novelty, it’s understanding what each product is really doing to your cash cycle and risk.
In this article, we’re going to discuss how to:
- Choose the right type of funding for the cash gap you actually have
- Stress-test the real cost and operational impact of non-bank lenders
- Put basic controls in place so short-term liquidity doesn’t create long-term pain
Why Liquidity Has Become Harder For SMEs
Liquidity means having cash available when obligations fall due, not just being ‘profitable on paper’. For SMEs, the gap between invoice dates, payroll, tax and supplier terms is where trouble starts. When costs rise quickly but customers take longer to pay, the working capital cycle stretches and cash drains.
Traditional bank finance often assumes stable, predictable cash flows and a clean set of accounts. In reality, many SMEs are seasonal, project-based or growing fast enough that historic accounts understate the cash needed today. Banks also price and structure lending around collateral and policy, not around the day-to-day frictions of trade credit, stock, or platform sales.
Alternative lenders stepped into that gap with products designed around transactions, invoices, card receipts, inventory and assets. That design can solve real problems, but it can also hide costs in fees, collections, or control of your receivables. Treat it as engineering: match the tool to the job, then check the failure modes.
How Alternative Finance For SMEs Works In Practice
Alternative finance for SMEs is a broad label for non-bank funding that usually underwrites a specific cash flow or asset, rather than offering a general-purpose loan based mainly on historic accounts. The trade-off is typically faster access and looser covenants, in exchange for higher cost, tighter control over cash, or both.
Invoice Finance (Factoring And Invoice Discounting)
Invoice finance advances cash against unpaid invoices, usually as a % of the invoice value, with the balance paid (minus fees) once the customer pays. Factoring often includes the finance provider managing collections, while invoice discounting can be more ‘behind the scenes’ with you still collecting.
It fits B2B firms with reliable invoicing and creditworthy customers, but it changes how cash hits the bank and can introduce operational demands: reporting, verification, disputes management and credit limits on your customers. It also doesn’t fix a business that sells to slow payers with frequent disputes. For general background, the British Business Bank has practical explanations of finance options used by smaller firms: https://www.british-business-bank.co.uk/finance-hub/.
Merchant Cash Advance And Card-Receipts Finance
These products advance funds and then take a fixed share of daily card takings until a target amount is repaid. They’re common in hospitality, retail and consumer services where a large share of revenue is card-based and settles through processors.
The risk is not just headline cost. If takings dip, repayments extend, which can drag on cash for longer than planned. If takings surge, you can end up repaying quickly at an effective high annualised rate. The right question is: what happens to cash coverage in the worst 2 months of your year, not the best 2 weeks.
Revenue-Based Finance
Revenue-based finance is similar in spirit to card-receipts finance but tied to revenue performance more generally, with repayments flexing as revenue changes. It can work for subscription businesses and some digital brands, where revenue reporting is consistent and margins support the repayment share.
Watch for how revenue is defined, how frequently it’s measured, and what happens if reporting systems change. Also check whether the agreement has minimum payments or step-ups that reduce the ‘flex’ right when you need it.
Asset Finance And Hire Purchase
Asset finance funds equipment, vehicles, machinery or other tangible assets, using the asset as security. This can protect working capital because you’re not draining cash to buy kit outright.
The catch is that the asset must be financeable and retain value. If you’re buying niche equipment, the lender may price in resale risk. It’s also easy to over-invest in assets because the monthly payment feels manageable, until demand falls and you’re still committed.
Trade Credit, Supply Chain Finance And Short-Term Working Capital Loans
Trade credit is supplier-funded working capital through payment terms. Some SMEs combine it with supply chain finance arrangements where a third party pays suppliers early and collects from the buyer later. These structures can smooth cash, but they can also reduce resilience if suppliers tighten terms or if a key platform changes settlement timing.
Short-term working capital loans from non-bank lenders can be useful for a defined, time-bound gap. The discipline is making sure the loan term matches the cash coming back. Funding a long, uncertain turnaround with a short, expensive product is how ‘bridging’ becomes permanent.
What SMEs Are Actually Using Alternative Finance For
In practice, SMEs rarely use one product in isolation. They stack tools to cover different parts of the cash cycle, then adjust as the business evolves. Common, legitimate use cases include:
- Covering payroll and VAT timing when receivables lag, especially in services and contracting
- Buying stock ahead of peak periods where the payback depends on selling through quickly
- Managing customer concentration when 1 or 2 large accounts dominate invoices and payment behaviour
- Reducing reliance on a single bank facility that can be withdrawn or repriced
Notice what’s missing: using short-term funding to paper over structurally low margins, weak collections, or persistent customer disputes. Alternative funding can buy time, but it can’t change unit economics.
How To Judge The Real Cost (And Not Get Fooled By The Headline)
With bank lending, people obsess over the interest rate. With alternative products, the cost is often a mix of fees, discounts, service charges and settlement controls. Two offers can look similar but behave very differently in real life.
Start with three practical questions:
- What is the total cash out over the full term? Include fees, minimum charges, audit fees and any settlement or platform costs.
- What cash does the lender control? Invoice finance and some receivables structures can route payments through a controlled account, which affects flexibility.
- What triggers tighter terms? Look for clauses tied to debtor ageing, disputes, concentration limits, or changes in trading volume.
If you need a baseline for what ‘payment practices’ and late payment pressures look like across the UK economy, the government’s guidance on reporting and payment practices is a useful reference point: https://www.gov.uk/guidance/check-when-large-businesses-have-to-report-on-their-payment-practices-and-performance.
Due Diligence: The Checks That Matter More Than The Pitch
Non-bank finance varies widely in quality. Some providers are professional, transparent and operationally solid. Others are loose on documentation, aggressive in collections, or vague about fees. Basic checks reduce the odds of nasty surprises.
Focus on the contract mechanics:
- Fees and charges: Identify fixed fees, variable fees, and what happens if volume drops.
- Personal guarantees: Understand what you’re signing and whether it’s limited or unlimited.
- Security and debentures: Check what assets are charged and how that affects future borrowing.
- Default definitions: Some agreements define default broadly, including administrative breaches.
- Control of receivables: Confirm where customers pay and who can redirect funds.
Then check the firm: if the provider carries out regulated activity, it may appear on the Financial Conduct Authority register: https://register.fca.org.uk/s/. Not every business finance product is FCA-regulated, so the absence of regulation isn’t automatically a red flag, but it does change your expectations around conduct and complaints.
A 90-Day Liquidity Playbook That Works With Alternative Finance
This is a practical sequence many operators use to stabilise cash before adding more funding complexity. It’s not glamorous, but it reduces the risk that new finance simply masks weak working capital habits.
1) Build A 13-Week Cash Forecast You Can Defend
A 13-week cash forecast is a weekly view of expected cash in and out. It forces discipline on timing, not just totals. Keep it simple: opening cash, receipts by customer, payments by category, then ending cash.
The key is update cadence. A forecast that’s refreshed weekly becomes a management tool, not a spreadsheet ritual. If your numbers swing wildly each week, that’s a signal to tighten invoice chasing, billing accuracy, or purchasing controls.
2) Separate ‘Working Capital’ Problems From ‘Profit’ Problems
If you’re profitable but short of cash, the fix is usually collections, stock turns, deposits, or terms. If you’re not profitable, funding buys time but increases risk. Don’t use short-term finance to avoid pricing decisions or cost resets that need doing.
3) Match Product Term To Cash Return
Funding stock for Christmas with a facility that repays from sales can make sense if sell-through is predictable. Funding a slow, uncertain turnaround with a fast-repay product often creates a spiral where repayments drain the very cash needed to recover.
4) Put Guardrails On How Facilities Get Used
Decide in advance what the facility is for, and what it isn’t for. Common guardrails include a maximum monthly draw, a minimum cash buffer, and a rule that new borrowing must link to a specific receivable or stock cycle rather than general overhead.
Conclusion
Alternative finance is neither a saviour nor a scam by default. Used well, it can smooth working capital and reduce the odds of a cash crisis. Used badly, it can lock you into expensive repayments, messy controls over receivables, and less room to manoeuvre when trading turns.
Key Takeaways
- Alternative finance for SMEs works best when it is tied to a clear cash cycle, not used as a permanent patch
- The real risks are often in contract terms, cash control and downside behaviour, not the headline rate
- A simple 13-week forecast and clear guardrails reduce the chance that short-term liquidity creates long-term damage
FAQs
Is alternative finance for SMEs more expensive than a bank loan?
Often, yes, but ‘more expensive’ depends on total fees and how fast the facility repays, not just an interest figure. The trade-off is usually speed and structure that fits trading cash flows rather than historic accounts.
Will invoice finance affect my customer relationships?
It can, especially with factoring where the provider contacts customers about payment. Invoice discounting can be less visible, but customers may still notice changes in payment instructions or chasing.
What’s the main risk with merchant cash advance?
The repayment share can squeeze cash in slower months, and the effective annualised cost can be high if repayment is rapid. It also ties you closely to card settlement flows, which can change with processors or platform terms.
How can an SME avoid becoming dependent on short-term funding?
Treat the facility as a tool for defined timing gaps and track it against a 13-week cash forecast. If borrowing keeps rising without a clear cash return, the issue is usually margin, collections, stock discipline, or overhead.
Disclaimer: This article is for information only and does not constitute financial, legal, tax or investment advice. Any finance product can increase risk, so terms, fees and suitability should be assessed carefully for your specific circumstances.
