How to effectively utilise a bank overdraft - part one

There may be times when operating your business you find that your usual cash flow is down and that it's affecting the way you spend money. Bank overdrafts provide a short term funding option that allows you to spend more money than you currently have in the bank.

A bank overdraft will balance your accounts by bridging the gap between your incoming and outgoing funds and is a more cost effective practice when compared to making a credit purchase, where the interest rates are much more damaging. Essentially, an overdraft provides the benefit of a safety net.

The first question to consider before making the decision to fund your business with an overdraft is whether an overdraft right for your business.

It's important to note that not every business will benefit from an overdraft and it is likely that yours may also fall in this category. Before committing to an overdraft you should consider:

  • How much you are allowed to overdraft is determined by your bank based on items like your cash flow, the timing of receipts and payments or seasonal trends in sales. It's essential that you are aware of your limit and you don't exceed or else you face the possibility of being hit with a surcharge.
  • Interest is also charged on the amount overdrawn and will be usually charged at a rate that is above the Bank Base Rate. In addition to this, some banks will also charge you an annual basis just for having the finance option available to you.
  • Remember, bank overdrafts provide short term financing, and there are other ways to finance your business dependent on your needs. You should only use the overdraft as a backup measure and shouldn't grow to constantly rely on it. 
  • The bank also has the ability to negotiate some form of security into the agreement. In the case of agreements where a larger overdraft is allowed the bank may require something tangible like a fixed asset to acts as a security for payment.

You have to remember that implementing an overdraft facility isn't a decision you will make by yourself. The bank will ultimately consider your cash flow and examine your banking history to decide whether your business is the right fit and how much of an overdraft they will allow.

So long as your business does show evidence of having good cash flow the bank will be able to determine that you can make repayments on and ongoing basis and the facility will most likely be made available to you.

If you find yourself consistently short on cash and over relying on your overdraft, here are some tips to help you plan for slow periods of cash flow.

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