Arranging an overdraft for your business – the basics

There may be times when you need access to extra funds to help with your business cashflow, or simply to know that a short-term lending facility is in place should you need it.


Here we look at the advantages and disadvantages of securing a business bank overdraft.

Advantages

• Overdrafts are easy to arrange
• An overdraft can provide a flexible source of finance, which you can access instantly (assuming your bank has agreed to provide the facility).
• You’re only charged when you use the overdraft facility, and won’t be charged to paying it off before you initially expected.
• Just having an overdraft facility in place can provide peace of mind – knowing that you have a potential source of funding in case things go wrong.
• Late paying customers and clients are frequent causes of cashflow problems for small businesses. An overdraft facility may alleviate this problem, although you’ll have to pay for the privilege.
• You will receive tax relief on any overdraft lending – i.e. the interest will be offset against your profits.

Disadvantages

• An overdraft should be seen as a temporary solution, rather than a long-term source of lending.
• Interest rates levied overdrafts are higher than fixed-term loans.
• Interest rates are often variable.
• If you exceed your agreed overdraft limit, you’re likely to face hefty penalties.
• You will need to have an active business current account.
• Your bank may seek additional personal guarantees to secure an overdraft for your business if you trade via a company. This will effectively over-ride the limited liability afforded to you by your company, if you have incorporated. If you’re self-employed, you and your business are treated as ‘one’ financially, so you will be personally liable to repay the overdraft anyway.
• As many businesses found out the hard way, during the last recession, your bank may have the ability to withdraw your overdraft facility at any time. Clearly, this could be potentially fatal to many businesses, so check the terms and conditions when arranging your overdraft for the first time. Your bank is unlikely to remove the facility unless it has specific reasons to do so – such as your business is facing ongoing financial issues.

Applying for an overdraft

Your bank will need to be reassured that your business is run in a financially prudent way, and that it has the ability to repay the overdraft. Here are some things you will need to consider when approaching your bank:

• You will need to explain why you need access to short-term funds, and how you intend to repay them (the higher the facility, the more details your bank will expect to see). The lender may ask to see your business plan.
• You must have a good record with your bank, and other creditors – and no black marks against your name when they carry out a credit report.
• You should be prepared to offer security in return – including personal assets, even if you have a limited liability company. Interest rates for secured overdrafts are typically lower, however.
• Make sure you use the overdraft facility responsibly, and let your bank know immediately if your business is experiencing any difficulties.
• Overdrafts are usually arranged for 6 to 12 month periods, and renegotiated at the end of the agreed term.

Further Fees

For obvious reasons, you can only arrange an overdraft if you already have a current account with the same bank. And, unsurprisingly, fees vary significantly between providers. Find out which of the following fees will apply to you:

• Arrangement fees – often levied when you set up the facility.
• Renewal fees – will typically be charged – often on an annual basis.
• The interest charged on the overdraft itself.
• You may be charged an additional fee if you need to increase the limit.
• Unauthorised borrowing fees – what if you go over your overdraft limit?