Business Overdraft: What is it and Should I Consider it?
A business overdraft allows businesses to access additional funds beyond what they have in their bank account.
A business will only need to pay interest on the money they’ve overdrawn.
This makes for useful cashflow solutions in situations like purchasing stock or equipment, paying staff, or even covering general expenses.
There are plenty of benefits for businesses that take up a business overdraft.
Business Overdrafts explained
Because of this, a business overdraft adds an element of flexibility within your cash flow and allows you to continue making withdrawals even if your account is low or empty.
Unlike loans and other business finance solutions, an overdraft is attached to a pre-existing bank account. To access an overdraft, you need to request this from your current provider.
If this isn’t possible, you may need to open an account with a different provider and request an overdraft there.
Like a normal business or credit card loan, the amount you borrow must be paid back. Interest for the overdraft is charged based on the amount you borrowed.
There’s an overdraft limit that differs from lender to lender. Some lenders have a limit of $500,000, with others up to $100 million.
Business overdrafts are perfect for businesses that:
- Want the convenience of extra funds linked directly to their transaction account
- Need to borrow $2,000 or more
- Need to cover cash flow shortages and unexpected expenses
Business Overdraft Pros and Cons
When it comes to a business overdraft, it’s important to weigh up the pros and cons to see whether it’s right for you and your business.
Pros
Safety net
A business overdraft acts as a safety net for when you quickly need access to additional funds.
Unlike a loan, you only need to pay money on the amount you withdraw, which makes it a relatively low-cost safety net you may never need to use.
Flexible term limits
Generally, you’ll be able to talk to your lender about the period you’d like the business overdraft to be available for and you may even be able to get it renewed.
You also have the option to close it at any time, but you will need to pay out any outstanding balance and fees.
Cash flow
If unexpected expenses present themselves, a business overdraft allows you to fund these costs when you don’t have the money on hand.
Choice of security
There are both secured and unsecured overdrafts for you to choose from.
We’ll discuss these in more detail below, but each has its own set of advantages and disadvantages.Â
Cons
Interest rates
While you won’t pay any interest on the balance of the overdraft you don’t use, you will be charged an interest rate (generally a daily rate) on the money you do draw upon.
These interest rates tend to be higher than business loan rates, so it may be worth tossing up if this is a better option.
For more information, read our blog on short-term business loans.
Fees
Excluding the interest fees, you may still incur business overdraft fees – even if you don’t use the account.
This can include things like application fees, annual fees, and late repayment fees.
Quick termination
As previously mentioned, you can call off your overdraft at any time. However, the bank can do the same thing and cancel your overdraft.
Alternatives
If you’re not sure whether a business overdraft suits your situation, there are always other options. A small business loan is a popular alternative.
You will need to pay interest on the whole amount rather than what you use, but you’ll be able to access larger amounts.
A business credit card is another way to access funds when you need to.
Like business overdrafts, business credit cards are essentially a line of credit with a pre-arranged limit, an interest rate and several fees.
Depending on what type of credit card you choose, you may be able to earn rewards points which can then be used for travel or retail.
For more, read our blog on credit cards.
There are other business finance solutions available, too.
You can borrow against individual invoices to unlock the capital they contain, or you can borrow against high-value assets to gain access to them while making payments.
Secured and unsecured overdrafts
When choosing to use a business overdraft, you have the option of secured and unsecured overdrafts.
A secured overdraft requires you to commit a range of assets, such as residential, commercial, and industrial property, to give you a line of credit.
Although terms vary between lenders, securing your overdraft means you might be eligible to pay a lower interest rate.
An unsecured overdraft means that you do not need to pledge any assets to your financial provider to access the facility.
Choosing an unsecured overdraft means you may incur a higher interest rate, as nothing is held against your loan.
However, it exposes you and your business to a lot less risk than a secure overdraft does.
Securing your overdraft also means you may be able to access a larger line of credit than if your loan was unsecured.
This is because the bank has the right to sell the assets you’ve put up as collateral if you’re unable to repay debts on your secured overdraft.
Depending on your financial situation, you may not get a choice as to whether you’d prefer a secured or unsecured overdraft.
If your credit rating history suggests that you may struggle to make repayments, it’s more likely you’ll have to secure your overdraft.
A business overdraft is a useful solution for businesses that need to access money quickly.
This may be to cover unexpected expenses, or even to purchase stock if a supplier has a good deal on offer. Choosing between a secured and unsecured overdraft allows you to have a bit of flexibility around the amount of interest you pay.
If you want more information on business overdrafts and if they’re the right option for you, talk to one of our commercial finance broker team members today.
