A business overdraft is a type of financial product offered by banks and other financial institutions that allows businesses to withdraw more money from their current account than they have available in the account to be used for business purposes and costs. It is a form of short-term borrowing that can help businesses manage their cash flow and meet their financial obligations.
An overdraft facility is usually set up as an agreement between the business and the bank, which specifies the maximum amount that can be borrowed and the interest rate that will be charged on the overdraft.
OnDeck does not offer business overdraft or line of credit solutions because of the drawbacks and risks for the customer. Business loans can also help businesses handle extra costs or unexpected expenses while having predictable repayment plans that don’t cause stress on the business.
How do you pay interest on an overdraft account?
The bank charges interest on the owed amount, so if you have an approved overdraft limit of $50,000, but have spent $20,000, you’ll only pay interest on the $20,000 of credit that has been used, not on the total approved limit.
What are the benefits of a business overdraft?
An unsecured business overdraft provides a flexible way for businesses to acquire the funds they need when it’s needed, helping manage cash flow to keep the business running smoothly.
Overdraft financing does not come with a regular payment schedule. When revenue goes into your account, it automatically goes towards what you owe. When your business has expenses beyond the money in your business transaction account, your debt increases.
Disadvantages of business overdrafts
While this flexibility is a boon to some businesses, the lack of business finance control it encourages for managing the business’s costs can cause problems, especially when relied on for the long term or if the bank insists on a secured overdraft or variable interest rates.
A business overdraft facility can also be dangerous because lenders can call in what is owed at any time, depending on the terms of the specific loan agreement. Compared to the schedule of loan repayments from business loans, this is an unreliable solution to short-term cash flow issues.
Banks may charge various fees, including transaction fees, overdraft fees, and maintenance fees, which can be difficult to predict and may add up quickly.
Transaction fees may be charged every time a business uses its overdraft to make a payment or transfer funds. Overdraft fees are charged when a business exceeds its agreed overdraft limit, which can happen if the business does not monitor its account balance closely or if unexpected expenses arise. Maintenance fees may also be charged to keep the overdraft facility open, even if it is not being used.
Example of a business overdraft
Imagine a small business that provides consulting services. The business has a steady stream of clients, but occasionally there are gaps in payment collections, causing temporary cash flow problems. In this scenario, the business may consider applying for a business overdraft from a bank.
Assuming the business is approved, the bank would provide the business with a predetermined credit limit, which would be based on the business’s creditworthiness, financial history, and other factors. The business can draw on the overdraft as needed, up to the agreed credit limit. For example, if the credit limit is $20,000, the business can draw on the overdraft up to $20,000, as long as it doesn’t exceed the limit.
If the business has $5,000 in its bank account and needs to pay a $10,000 vendor invoice, it can draw on the overdraft to cover the remaining $5,000. The bank would charge the business interest on the $5,000 overdrawn amount, which would accrue until the business repays the overdraft.
Once the business receives payment from its clients and the cash flow improves, it can repay the overdraft by depositing funds into its bank account. The interest charges on the overdraft would stop once the balance is paid off.
Is it better to have a business overdraft or a loan?
The answer depends on the exact needs of your business. We recommend obtaining professional financial advice before exploring either option. The general rule is that an overdraft facility is useful for small but regular amounts of extra cash over a short period of time, while a business loan can assist with larger amounts (up to $250,000 with OnDeck Business Loans) and is good for ongoing cash flow, working capital or purchasing bulk inventory. A business loan also has the advantage of giving you a reliable repayment schedule, making it easier to plan your business spending.
Prepared by OnDeck Capital Australia Pty Ltd ABN 28 603 753 215 (“OnDeck”) for general information purposes only. Content may belong to or have originated from third parties and OnDeck takes no responsibility for the accuracy, validity, reliability or completeness of any information. Information current as at March 2023. You should not rely upon the material or information as a basis for making any business, financial or any other decisions. Loans issued in Australia are subject to the terms of a loan agreement issued by OnDeck. Loans are subject to lender approval. OnDeck® is a Registered Trademark. All rights reserved.