A business overdraft is a line of credit which allows for transactions and withdrawals to be made when a business bank account balance is at zero. It is often included as part of an account and therefore many business owners have access to one. Funds may be drawn and redrawn up to an agreed credit limit without re-application.
It allows businesses flexibility over their cash flow. If their funding requirements are regularly changing or they have inconsistent or lumpy cash flow, it allows them to smooth gaps without requiring further loans.
It will often come as part of a regular business account, attached to the debit card. Cardholders can continue to spend when the account is empty up to the approved limits.
Interest is charged daily on the outstanding balance and there is usually a period in which the debt must be repaid. Typical facilities include an annual fee (which will vary from 0.25% - 2% of the limit).
Some banks will offer a temporary overdraft facility for a fixed period only, such as for 1 month, after which it must be repaid. There will usually be a limit on the number of temporary overdrafts a customer can utilise within a year.porary overdrafts a customer can utilise within a year.
What is a business overdraft used for?
A business overdraft should not be used as core debt. It is there as a safety net to meet quick or unexpected funding needs and is considered a general-purpose funding solution.
Business overdrafts are recommended for:
- Helping to manage cash flow - particularly if that cash flow is uneven or seasonal
- Paying staff (whilst waiting for clients to pay invoices)
- Short-term opportunities (stock, materials) when cash is needed quickly and for a short time
- One-off unexpected operating expenses
Business overdrafts are not recommended for:
- Long term capital expenditure (such as the purchase of machinery, equipment, vehicles or other large assets)
- Everyday use (where there is little or no working capital in the business)
Who is it suited for?
- Seasonal businesses - if a company makes money at specific events throughout the year, it can help cover the gaps between them
- Recruitment and labour-hire - who run payroll weekly for contractors, but their clients pay less frequently
- Project-based companies where clients pay on completion of work, but the business must still meet ongoing operating costs
- Importers and exporters with shipping and purchasing costs
Advantages and disadvantages of a business overdraft
|Speed and ease - it gives the business access to immediate financing and the ability to take advantage of short-term opportunities||Interest rates can be higher than other types of funding, such as a business loan|
|Flexible term and no need for reapplication||Fees apply (even if you don’t use it, such as application fees, annual fee, late payment fees|
|Safety net - it's there before you need it, only pay interest when you use it||Often subject to misuse. It's tempting to use it for ongoing working capital needs and larger expenses|
|It can be secured or unsecured, so rates can vary depending on the business||Qualifying can be difficult - lending criteria includes often includes security and a good record (strong cash flow, 3 years of statements)|
Other types of business finance
A form of commercial funding guaranteed by the assets of the applicant business. Often this will be property (usually the business premises, but can be personal), but also equipment such as machinery or vehicles or other suitable collateral. The loan is fixed-term.
A bank is usually the financier for secured loans. Loan repayments are over an agreed number of months with fixed or variable interest and fees. Should the borrower fail to pay, the assets could be repossessed by the lender to recoup the money borrowed.
In comparison to other types of funding, rates can be favourable and loan terms longer. Due to the security requirements and more stringent eligibility criteria, these loans can be difficult for smaller businesses to get approval for.
In contrast to a secured business loan, unsecured loans are not guaranteed by the fixed assets of the borrower. As such, there is a greater risk on the financier - there is nothing to repossess should the business fail to pay. This means interest rates are usually higher.
Also, a fixed-term loan, but generally with a shorter repayment period as well as lower loan amount - as such is considered a short-term business loan.
Offered by banks, as well as non-bank lenders. Suitable for businesses unable to get a secured loan, due to their financial history or lack of collateral to put up as security.
Business line of credit
Like a business overdraft, it is a line of credit that can be drawn on as required with the agreement that the balance is repaid regularly. Limits tend to higher and is used by more established businesses. Needs to be applied for separately.
Used for planned working capital needs, such as regular seasonality or stock opportunities.
Business credit card
Similar to a personal credit card, although it is used for small business expenses and can have multiple cardholders. It is generally not recommended for operational costs such as working capital, due to the high-interest rates.
Used for short term expenses and is usually paid off within the same month during the interest-free period.
A type of funding used by businesses to access funds tied up in their accounts receivable ledger. It can come in the form of upfront funds or a line of credit.
Used to ease ongoing cash flow issues resulting from payment terms on invoices.