An overdraft is a temporary facility added to bank accounts where you are able to be overdrawn in your bank account by a certain amount. You are charged interest based on the amount overdrawn and the length of time overdrawn, and are usually charged a regular fee for the use of the facility.
An overdraft is particularly useful when you have regular sales and purchases coming out of your account which could leave you in bad cashflow situations. They are a good backup to ensure you can pay your bills even when you have not yet received your invoice payments. (Another good finance solution in this situation is Factoring)
An overdraft is not supposed to be a permanent source of finance, and if your business is relying on using it, you should get your finances checked out.
Advantages of Overdrafts
Flexible – An overdraft is there when you need it, and costs nothing (apart from possibly a small fee) when you do not. It allows you to make essential payments whilst chasing up your own payments, and helps to maintain cashflow. You only need to borrow what you need at the time.
Quick – Overdrafts are easy and quick to arrange, providing a good cashflow backup with the minimum of fuss.
Disadvantages of Overdrafts
Cost – Overdrafts carry interest and fees; often at much higher rates than loans. This makes them very expensive for long term borrowing. You also face large charges if you go over the agreed overdraft limit.
Recall – Unless specified in the terms and conditions, the bank can recall the entire overdraft at any time. This may happen if you fail to make other payments, or if you have broken terms and conditions; though sometimes the banks simply change their policies.
Security – Overdrafts may need to be secured against your business assets, which put them at risk if you cannot meet repayments.
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