Business overdrafts – what you need to know
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As the saying goes, cash is king. Therefore, effectively managing your cash flow is a key to the success of your business. That’s why business overdrafts can be really useful.
A business overdraft provides a bit of a safety net – because it doesn’t matter what industry you're in, things change. Things that might be out of your control, but that can directly impact your cash flow.
The principles of a business overdraft are the same as a personal overdraft. But there’s a lot more to consider with the former, and that’s exactly why we’ve created this guide to business overdrafts.
By the end, you’ll know how they work, the fees associated with them, the advantages and disadvantages, and the alternative finance options available. That way, you’ll be able to make a more informed decision about whether having a business account with an overdraft is right for you.
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What is a business overdraft?
If your business account has an overdraft facility, you can access more money than the amount you have in the account. Simple, right?
This gives you greater cash flow flexibility and can be particularly useful in helping deal with emergencies and short-term funding needs, such as:
- Settling invoices you owe
- Covering overdue invoices owed to you
- Buying stock
- Paying for unforeseen expenses
- Managing supply chain issues
How does a business overdraft work?
A business overdraft works by allowing you to continue to access funds even after your current account balance drops below zero.
You have to pay back the money, of course. And like a business loan or business credit card, you'll have to pay interest on the amount of credit borrowed. Once you repay the outstanding figure and your account goes back above zero, you stop paying interest.
The overdraft will have a limit, which is set by your overdraft provider – usually a bank. This limit can vary from hundreds of pounds to millions and will be determined by several factors, including your business turnover and credit history.
If your cash flow circumstances change, it is possible to increase your overdraft limit. The bank will only do this if they believe the business can effectively pay back the additional funds borrowed.
If the bank has concerns about you repaying the overdraft, or you’re asking for a large sum, the business overdraft might have to be what's called a ‘secured’ overdraft.
What’s the difference between a secured and an unsecured business overdraft?
With a secured business overdraft you’ll need to use a business asset (such as a commercial property you own) as security, whereas with an unsecured business overdraft you won't.
If you have a secured overdraft and can't pay it off within a certain time period, the bank could sell your asset to recoup the money you owe. In contrast, while an unsecured loan doesn't require an asset as collateral it is more likely to have a higher interest rate.
How to get a business overdraft
Normally, you can only get a business overdraft with the bank you have your business current account with, so that’s exactly who you need to contact. Depending on your bank, you can usually apply by going in branch, by calling or by going online.
To qualify, you’ll need to meet your bank’s eligibility criteria. This will involve them reviewing your business, and its financial history. To check you’re a reliable borrower, your personal and business credit history will also be checked.
As part of your application, you may also have to outline how you’ll use and repay your overdraft. And typically, the larger the overdraft, the more details you’ll need to supply.
If your business overdraft application is declined, don’t panic. There are other ways to finance your business to meet your funding gaps or achieve your goals.
Formal business overdraft requests
This is where you polish your shoes and put your best suit on to visit your bank in advance to arrange an overdraft. Or stay in your jeans and trainers and call them. Either way, you’ll have an agreement in place before you spend more than the amount of money you have in your business current account.
At the meeting, where hopefully you’ll get a chocolate digestive if nothing else, is when the interest rate charge and the duration of the business overdraft is confirmed.
Informal business overdraft requests
This is where you go overdrawn or exceed your agreed overdraft limit, without contacting your bank first.
If you had a business overdraft already in place, and you went over it, you’ll probably be charged a penalty fee and a different (usually a lot higher) interest rate on the extra money you borrowed.
If you didn’t have a business overdraft in place before going overdrawn, you’ll be charged a penalty fee and interest on the amount you went over by. Once again, this interest rate is likely to be a lot higher than the interest charged on a pre-arranged business overdraft.
Shoot for the moon with your business. Image: Jakob Owens
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