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What’s a Business Overdraft?

What’s a Business Overdraft?

A business overdraft is one type of business finance used by many SMEs. Learn about the pros and cons of business overdrafts.

When you get a business overdraft, the bank has given you credit for a certain amount on your regular business transaction account. For example, if your approved overdraft limit is $10,000, you can have a negative account balance up to that amount. 

A business overdraft is like a line of credit in that you have a maximum credit amount and only pay interest on what you borrow. So if you only use $5,000 of the $10,000 approved limit, you will only pay interest on $5,000. Of course, the amount you have drawn will fluctuate as you receive and spend money. This flexibility makes it a convenient alternative to a business loan if you get credit approval. 

When should you use a business overdraft?

A business overdraft can be helpful if your cash flow fluctuates. For example:

  • You work on long-term projects but only get paid when the work is completed.
  • Your sales are seasonal, but you need to pay staff and buy inventory throughout the year.
  • You have new business and you need to cover costs before your start earning an income.
  • You have had customers fail to pay their debts and you need assistance until your cash flow recovers.

What’s needed to be approved?

Banks look at several factors before granting a business overdraft. These include how long you have been in business, your turnover, whether you have equity in a property or other assets to secure the loan, and why you need the finance.

Differences between secured and unsecured business overdrafts

There are two types of business overdrafts – secured and unsecured. With a secured overdraft you pledge property or another asset as collateral. This is required if you want to get a higher limit, usually over $50,000.

With an unsecured overdraft, you don’t need to pledge collateral against the overdraft. Ultimately, however, if your business runs into difficulties and you fail to repay, the bank will have recourse to your assets.

Another difference between secured and unsecured business overdrafts is the interest rates.

With a secured version, the bank secures the loan with collateral. The reduced risk means that the interest rate on secured overdrafts is lower.  The interest rate on an unsecured overdraft is usually 1.5 times higher than for the unsecured overdraft. For example, if the interest rate for a secured business overdraft is 8.00%, the rate for the unsecured overdraft will be around 12%.

The benefits of getting a business overdraft

One of the main benefits of business overdraft is that it’s relatively easy to get if you meet the criteria outlined above. A bank will look at these factors to determine the approved limit. It usually only takes a few days to get an answer if you are an established bank customer, so it’s a fast finance option if you are approved.

Another plus of this type of business finance is that there is not a regular payment schedule. When revenue comes into your account, and exceeds your expenses, the amount you owe goes down. On the other hand, if your expenses exceed the revenue coming into your account, your debt (amount you have overdrawn) increases.

In addition, the interest rate on an unsecured or secured overdraft is lower than you would typically pay on a credit card.

Know the shortcomings of a business overdraft

An application fee is required to open a business overdraft. In addition to the interest charged, fees and charges apply with business overdrafts. You will also be charged a fee if you go over the approved limit. So the potential fees charged can add up quickly. You can also end up paying more if your business overdraft has a variable rate. 

Another big drawback is that an overdraft facility can be called in at any time. This means the business banker can demand repayment of the entire amount owed immediately. The fact that a business is using an overdraft means it probably does not have any excess cash. So the demand for repayment could place the business in a very difficult position.

Get a comprehensive overview of business loan options, including online and traditional business banking options, in The Complete Guide to Business Loans in Australia.

Author:

All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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