All you need to know about business overdrafts
What is a business overdraft?
A business overdraft is a line of credit that provides relief and helps to cover some of the unexpected expenses. The credit is often activated when you make a withdrawal larger than your account balance in the business debit account. Think of this kind of loan as a safety net that covers you when your business runs out of cash to cover its expenses.
In essence, this means you can continue withdrawing from your business account even when it’s empty, which gives you flexibility in your cash flow. This kind of credit can allow you to pay your employees on time even when your clients have delayed paying. Of course, your business must repay what you spend, just like a business loan or credit card. Interest is usually charged based on the amount of credit your business has used.
A business overdraft usually comes with a limit, which works more like a credit card limit. Financial institutions are currently offering a minimum credit amount of about $1,000 up to a whopping $10 million maximum credit limit. But you don’t want your business paying a hefty interest on a $10 million debt unless you really need it.
An overdraft credit can be unsecured or secured. You can use business property or assets as security when advancing a secured overdraft. If you advance a secured overdraft for your business, the financial institution can sell the property or asset your business used as security to recover their dues if you don’t repay in time.
When applying for a business overdraft, most lenders require that you show a solid and stable business turnover, have equity in a property that you can use to secure your loan and in some cases, demonstrate a legit business need for the loan. Most financial institutions will issue unsecured overdrafts of up to $100,000. If you need more, the lender will most likely need some security to secure the extra credit.
Examples of how a business can use a business overdraft
Seasonal businesses: If your business makes most of its income in a certain season of the year but requires some credit to settle its running expenses, an overdraft can come in handy before the next season peaks. For instance, a retail business that makes a bulk of its income during the Christmas season can use an overdraft to settle salaries and expenses during lower seasons.
Setting up a company: You can use an overdraft to help cover supplier and staffing costs during your initial launch phase before the business starts earning income.
Long-term contracts: if your business has a long-term contract and needs to pay to cover its expenses before completing, a business overdraft can help. This is common with construction companies which are paid a bulk of their income after project completion –they can use an overdraft to pay for materials and staff during construction.
Client default: if a major client in your business defaults on payment, you can use an overdraft to pay for your operating costs until your cash flow stabilizes.
Pros and cons of a business overdraft
- An overdraft can offer your business with a flexible line of credit
- A bank overdraft is easy to arrange
- Your business is only charged when you actually use the overdraft facility
- Having an overdraft provision provides a piece of mind
- You can apply for the business overdraft at any time
- Overdraft interest rates are typically higher than those of standard business loans
- Interest rates for most lenders are variable
- Exceeding agreed overdraft limit may attract hefty penalties
- You need to have a solid, active current business account
- Your lending institution may withdraw the overdraft facility at any time –always check the terms.
What Charges and fees Apply?
Application fee: there is usually no application fee, but some institution tend to charge for it
Account-keeping fees: this is an ongoing fee that goes towards managing the overdraft facility. But again, this is not common
Interest rate: this is charged on the overdraft credit your business spends. They vary among lenders but typically range between 5% and 12%.
Over-limit fee: this is a penalty for the amount withdrawn exceeding the overdraft credit limit.
Establishment fee: This is a fee charged during the setup of an overdraft facility. It’s usually negotiated between financial institution bases in the nature and terms of the overdraft.
Business overdraft alternatives
Merchant cash advances: this is a good alternative to overdrafts if your business accepts payment using credit card machines. They are more like loans but are specially pegged in your future card sales.
Revolving credit facilities: this closely resembles the bank overdraft since your business receives a pre-approved credit limit. This is however not tied to your bank account and you can decide which account should be used when you apply for the overdraft.
Invoice finance: if your business gets paid in terms of invoice finance, your lender can advance you a percentage of the face value of your invoice earlier so that you don’t have to wait.
Example of institutions offering business overdrafts
Some of the most notable business overdraft facility providers in Australia include;
- Suncorp-Metway Ltd
- Australia and New Zealand Banking Group Limited (ANZ)
- Bank Australia Limited
- Commonwealth Bank of Australia (Bankwest)