A business overdraft is a financial arrangement which allows you to continue making payments, even when there is no cash left in your bank account. You can use this on paying wages, covering day-to-day expenses and more.
Business overdrafts can be a great way to give your company spending power when it wouldn’t otherwise have any. This would only ever be used when it is absolutely necessary, therefore, it can be a valuable short-term funding solution.
What is a business overdraft?
A overdraft is when your business bank account has use of a seperate finance facility. Companies are able to apply for an overdraft with their banks, though that doesn’t mean you have to use the money, it can just work as a form of security if you’d prefer.
For instance, if you think cash could possibly run a little low this month, and your cash flow may suffer though you aren’t sure, you may consider an overdraft facility without being sure you’ll actually need it.
Overdrafts are not a secure source of medium- or long-term business finance, as banks are able to reserve the right to ask for repayment upon request. If you need medium or long-term solutions, see our section of alternative financing deeper into this article
.In June 2019, the Financial Conduct Authority (FCA) published an article. This confirmed that it was their intention to be a ‘shake-up to the overdraft market’ (PDF).
The new rules will come into place in April 2020, they are designed to make overdrafts easier to manage and fairer to the borrower.
Why would a business use an overdraft?
A business would use an overdraft to cover unexpected expenses. Many businesses choose to use an overdraft because it is a quick and easy way to get the money they need. Another advantage of using an overdraft is that it can help businesses avoid bounced checks or late fees. In addition, an overdraft can provide a safety net for businesses in case of emergency.
For example, if a business needs to make a large purchase suddenly, an overdraft can help them avoid taking out a larger loan with higher interest rates. Overall, an overdraft can be a helpful tool for businesses when used wisely.
How does a business overdraft work?
A business overdraft works by allowing you to access funds within your current account once the balance drops below zero.
The money has to be repaid, but businesses take advantage of these types of facilities. Like business loans or business credit card, interest is payable on the amount of credit borrowed. Once you the outstanding figure has been repaid, your account goes back above zero, you will then stop paying interest on the amount you used.
Business overdrafts have a limit, this limit is set by your bank. The limits of the overdraft vary from hundreds of pounds to millions, these amounts are determined by several factors. These include the business turnover, credit history and its fixed assets.
Should the businesses cash flow circumstances change, there is a possibility to increase the overdraft limit. Banks will only do this if they believe the business can effectively pay back the additional new funds it has borrowed.
If the bank is worried about the repayments of the overdraft not being met or the company is asking for a large sum, the business overdraft might be turned into a facility called a ‘secured’ overdraft.
This means that the bank will require security from the company, by way of a charge on a property, a debenture on the company or a personal guarantee.
What’s the difference between a secured and an unsecured business overdraft?
Businesses often need access to quick and easy financing in order to cover unexpected expenses or seize opportunities as they arise. An overdraft can provide this type of flexible funding, allowing businesses to withdraw more money than they have in their account up to a specified limit.
There are two main types of business overdrafts: secured and unsecured. A secured overdraft is backed by collateral, typically in the form of business assets such as property or equipment usually by the use of a fixed charge. This collateral gives the lender a cushion of security, which can result in lower interest rates and more favorable terms.
An unsecured overdraft, on the other hand, is not backed by any collateral. As a result, it generally comes with higher interest rates and stricter terms. For businesses that don’t have the necessary collateral for a secured overdraft, an unsecured option may still be a viable choice for short-term financing needs.
How to get a business overdraft
A business overdraft is an account where you can borrow money from the bank when your business is running low on cash. This can be a useful safety net for times when you have unexpected expenses or your income drops unexpectedly. To get a business overdraft, you will need to make an appointment with your bank manager and provide some financial information about your business.
They will then assess whether or not your business is suitable for an overdraft and how much you can borrow. If you are approved, the overdraft will be added to your business account and you can start using it immediately.
There may be interest charges on the account, so it is important to only borrow what you need and to make sure you repay the money as soon as possible. Overdrafts can be a helpful tool for managing cash flow, but they should be used carefully to avoid getting into financial difficulty.
Formal business overdraft requests
When a business owner finds themselves in need of extra funds, they may consider requesting an overdraft from their bank. An overdraft is an arrangement with a financial institution that allows a business to continue withdrawing money even if their account balance falls below zero. This can be helpful in situations where a business needs to cover an unexpected expense or make a last-minute payment. However, it’s important to note that overdrafts can come with significant costs, including fees and interest charges.
As a result, businesses should only consider this option if they’re confident they can repay the amount borrowed within a reasonable timeframe. For businesses that rely on regularly accessing their overdraft, it may be more cost-effective to consider other options, such as loans or lines of credit.
Informal business overdraft requests
Requesting an informal business overdraft can be a tricky proposition. On the one hand, you don’t want to seem like you’re not organized or like you’re desperate for cash. On the other hand, you want to be confident that you’ll be able to repay the debt in a timely manner. The key is to strike the right balance between these two extremes.
When making your request, be sure to emphasize your business’s strong track record and financial stability. Explain why you need the extra funds and how you intend to use them. Finally, offer a detailed repayment plan that includes both interest and principal payments. By taking these steps, you’ll increase your chances of getting approved for an informal business overdraft.
There are a number of advantages and disadvantages to an overdraft here are a few of them:
Advantages to a business overdraft
- Overdrafts are highly useful for short-term business funding
- You only borrow when you need the cash, you do not have to use the full amount
- This is a flexible funding solution, as you can reach an agreement that suits your business’ needs
- You will only ever pay interest on the overdrawn balance, which is a positive for those that are smart with their finances
Disadvantages to a business overdraft
- Overdrafts are sometimes difficult to extend if additional funding is ever needed; access to funds can become limited or even cut off completely
- You can be hit with unexpected overdraft fees or charges if you do not select the right option
- Banks are able to call in an overdraft at short notice, making things difficult to deal with and unexpected at times
- Business loans will often allow you to borrow a higher amount of money than overdrafts
- The allowance will be based on your business’ income, which means some companies will struggle to get funding when they need it the most
Business account overdraft fees and charges
Overdraft fees and charges can be a major financial burden for businesses. An overdraft occurs when a business account is drained of funds and is unable to cover its obligations. When this happens, businesses are typically charged a fee by their bank. In addition, businesses may also be charged interest on the amount of money that is overdrawn.
Overdraft fees and charges can add up quickly, and they can be difficult to pay off. As a result, businesses should be careful to avoid overdrawing their accounts. One way to do this is to keep track of expenses and to make sure that there is always enough money in the account to cover them. Another way to avoid overdraft fees and charges is to sign up for an overdraft protection plan.
This type of plan allows businesses to link their checking account to another account, such as a savings account or a line of credit. This way, if the checking account is ever depleted of funds, the other account can be used to cover the shortfall.
Application fee
An application fee is definitely one to look out for. Most banks don’t charge this, so if yours does, certainly question it.
Account-keeping fee
Account-keeping fee is an ongoing charge that is charged by your bank for managing the overdraft.
Arrangement fee
An arrangement fee is something you have to pay upfront to the bank for setting up the business overdraft facility for you.
Unarranged overdraft/over limit fee
Unarranged overdraft or over limit fees are when you exceed your overdraft credit limit and you’ll be hit with a penalty charge. You’ll also probably have to pay an increased interest rate charge on the money that went over your limit.
Annual/renewal fee
Annual or renewal fees are a one-off fee charged every year. This could be a flat rate or a percentage of your agreed overdraft limit.
Change fee
Change fees are issued when you want to change your business overdraft limit.
Does a business overdraft affect credit rating
Many businesses rely on credit to help with cash flow or cover unexpected expenses. While credit can be a helpful tool, it’s important to understand how it can affect your business’s credit rating.
One common form of credit is an overdraft, which allows you to withdraw more money from your account than you have available. Overdrafts can be a convenient way to cover short-term shortages, but they can also have a negative impact on your business’s credit rating.
This is because overdrafts are considered a type of debt, and businesses with high levels of debt are often seen as higher-risk borrowers. As a result, if your business frequently uses an overdraft, it could end up with a lower credit score.
If you’re concerned about how an overdraft might affect your business’s credit rating, it’s important to speak with a financial advisor. They can help you better understand the potential risks and benefits of using this type of credit.
Is a business overdraft better than a loan?
Many business owners find themselves in need of extra funds at one point or another, and there are a number of options available to help meet this need. Two of the most popular choices are overdrafts and business loans. So, which is the better option?
It depends on a few factors. One key consideration is the interest rate. Overdrafts typically have higher interest rates than loans, which means that they can end up costing more in the long run. Another important factor to consider is the fees associated with each option.
Overdrafts often come with a monthly fee, while loans may have an origination fee or prepayment penalty. Finally, it’s important to think about how you will use the funds.
If you only need a small amount of money for a short period of time, an overdraft may be the better option. However, if you need a larger sum of money for a longer period of time, a loan may be a better choice. Ultimately, the best option depends on your individual circumstances.
Is a business overdraft right for you?
Every business has different circumstances, so the simple go to option for securing extra funds may not always be the best move, check out if Invoice Finance compared to and overdraft is the best option for your venture.
You should now have a better understanding of business overdrafts, you can be in a better position to decide if it is the right type of borrowing for your business or alternatively maybe look at a different source of funding, is right for your business.
Conclusion
In conclusion, a business overdraft serves as a vital lifeline, offering essential financial support to businesses during their times of need. Whether facing unexpected expenses, cash flow shortages, or sudden opportunities that require immediate investment, an overdraft facility allows businesses to bridge the gap without resorting to more costly or time-consuming alternatives.
Its flexibility and accessibility enable entrepreneurs to maintain operations, meet financial obligations, and seize growth opportunities, thereby bolstering the overall resilience and sustainability of their enterprises. By leveraging a business overdraft responsibly and judiciously, businesses can navigate challenging economic climates and uncertainties, fostering continued growth and success in the long run.
As a reliable financial tool, the overdraft remains a valuable asset for entrepreneurs striving to weather turbulent times and thrive in today’s dynamic business landscape.
Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.