What is a business overdraft?

A business overdraft is a short term credit facility that can be used to access cash flow when your business needs it. It’s commonly used among small businesses who need to borrow some extra funds and can be an effective financial tool, providing a safety net and more flexibility in how you manage your finances. 

However, a business overdraft may not always be the most cost effective option, and fees or interest can be difficult to calculate. In this article we’ll look at business overdrafts, the pros and cons, and how to use them effectively. 

How does a business overdraft work?

If you have a personal current account with an overdraft, then you’re already up to speed with the basic principles of a business overdraft. 

If you have a business current account with your bank, you can apply for an overdraft, and they’ll assess if you’re eligible and how much they can offer you as an overdraft limit. 

If approved, you can then take out or spend funds up to your overdraft limit, even if you have no funds in your account. Unlike a loan, you may not have a set time to repay the funds, but your bank will likely charge you for the period you’re overdrawn. 

How much do overdrafts cost?

Once you’ve borrowed money and gone into your overdraft, you’ll typically pay interest and/or fees until that money is repaid. Interest and fees will vary by provider, but you may be charged interest or fees on your full overdraft limit, even if you are only using a small part of it. 

Depending on the provider, you may also be charged monthly or annual fees for having the facility available, even if you don’t use it.

If you’re using your business current account regularly with lots of incomings and outgoings, the amount you’re overdrawn can be constantly shifting. As a result, the cost of using an overdraft can be difficult to calculate, making it harder to track than other forms of credit with fixed costs. 

What can I use a business overdraft for?

When a business overdraft has been agreed, your business can access more funds than are currently available in your business bank account. The reasons why you might want to do this are hugely varied, from unexpected costs to seeing an opportunity that you want to capitalise on straight away. Other reasons for arranging a business overdraft could include:

• Buying extra stock to deal with a spike in demand
• Settling invoices which are in danger of becoming overdue
• Paying for repairs
• Covering rising costs
• Bridging cash flow gaps when an incoming payment is delayed

How much can I borrow with a business overdraft?

Overdraft limits will vary by provider. If you apply, they will assess how much they believe you can afford to borrow, looking at factors such as turnover and credit history. Businesses who keep a good repayment record may also be eligible for an increase of their overdraft limit.

How to apply for a business overdraft

To apply for a business overdraft you can speak to your existing current account provider if you have one, or shop around for the best overdrafts currently available. 

They will likely run credit checks on your business to assess how much you can borrow. 

The pros and cons of a business overdraft

Pros

A business overdraft offers a convenient solution to short term cash flow problems.

You can use it as much or as little as needed, with no obligation to use the full amount of the business overdraft.

A business overdraft is a flexible solution and without a set repayment schedule. 

Cons

The total cost of using an overdraft can be hard to calculate, and can be more than other forms of credit such as term loans or lines of credit

The bank you borrow from may reserve the right to ‘call in’ the business overdraft at short notice, in which case you would have to quickly find the money to pay back the amount borrowed in full. 

In most cases, a business overdraft will be smaller, in cash terms, than a business loan. 

How to get out of a business overdraft

You may decide that you want to clear your business overdraft, either because you want to reduce your debt, or want to switch to a lower cost alternative. A debt consolidation loan can be a quick, affordable option to get out of your overdraft fast. You’ll then have one simple monthly repayment with clearly defined costs, helping you manage your cash flow. 

Alternatives to a business overdraft

FlexiPay, a line of credit offered by Funding Circle, gives you the same flexibility as a business overdraft without the confusing costs. You can get a credit limit of up to £250,000, which you can use for paying invoices, unexpected costs, bills, payroll and more. It’s free to set up and you’ll only pay when you use it, putting you in control of your cash flow.