The Pros and Cons (and Alternatives) of a Business Overdraft

If you’ve ever used an overdraft facility on your personal account, then you’ll have a good idea of how a business overdraft works. This fast, flexible, short-term credit facility is great for covering unforeseen expenses and cash flow gaps on short notice. 

However, there are other equally fast and flexible funding options available to businesses that do not incur the same variability of costs as a business overdraft. We wrote this handy article to explore the pros and cons of a bank overdraft for your business, as well as an informative comparison with a favourable alternative. 

What is a business overdraft? 

A business overdraft facility is a short-term credit arrangement between a business and a bank that allows the business to withdraw from the account even when there are zero funds in it. Functionally, it serves as a safety net, allowing businesses to “overdraw” on the account balance to cover cash flow shortages at a moment’s notice.

There are two types of business overdrafts: authorised and unauthorised. An authorised overdraft is arranged beforehand with the bank and typically incurs lower rates. An unauthorised overdraft is when the business spends more money than there is in the account without arranging it beforehand, which results in higher fees. Business overdrafts are not designed for long-term use. They are subject to the bank’s terms and conditions, including the possibility of termination or the bank “calling in” the overdraft on short notice. 

How does a business overdraft work? 

Businesses can apply for an overdraft facility with their bank. Typically, the process involves a review of the applicant’s turnover and credit history, which can take some time to complete. 

Once the business has successfully applied for an overdraft facility, it can continue transacting on an “empty” account — effectively borrowing against accounts payable but through the bank. The amount borrowed from the overdraft facility will incur a range of charges, including interest, arrangement fees, and penalties for exceeding the limit. 

Businesses typically use overdraft facilities to cover short-term expenses such as purchasing extra inventory to meet a spike in demand, paying for repairs, settling invoices that are close to being overdue, and bridging cash flow gaps when incoming payments are delayed. 

Pros and cons of a business overdraft facility 

The primary appeal of the business overdraft is its accessibility. Businesses can keep running even when there are technically no funds in the account and, once the overdraft has been approved, businesses don’t have to wait to borrow funds. However, other aspects of the business overdraft make it a less sustainable borrowing option. It comes down to your cash flow needs. 

Pros of a business overdraft facility 

• Convenience
• Businesses are under no obligation to use the full amount of the overdraft
• A flexible funding option without a set repayment schedule 

Cons of a business overdraft facility 

• It can be tricky to know the true cost of finance, especially if funds are constantly coming in and going out of the account (which puts the amount you are overdrawn in constant flux) 
• Businesses often have to pay fees on the full amount of the overdraft facility, even if they only use a fraction of it 
• Incurs a range of costs including annual or establishment fees (the bank’s “insurance” for going below zero) as well as interest rates and penalties for exceeding the limit 
• Banks can demand the full settlement of the facility at any time 

What are some business overdraft alternatives? 

If your business is looking for flexible financing options that are quickly and easily accessible to cover cash flow gaps, there are alternatives to business overdrafts available. Many alternative financing options offer a more intentional approach to borrowing, providing speed and flexibility with more stable and sustainable terms. For flexible short-term borrowing, we’d recommend a business line of credit. 

Business overdraft vs. business line of credit 

A business line of credit is similar to a business overdraft in that they are both short-term credit facilities, the limit of which is predetermined so that the business can borrow any amount it needs at short notice. However, a business line of credit represents a more intentional approach to borrowing and typically incurs more transparent and lower financing costs, which can be more sustainable for businesses in the long term. 

Bridgement business line of credit	Business overdraft facility
Instantaneous access  Access your credit facility online 24/7. Request and receive funds in a matter of minutes.	Instantaneous access Quickly request and receive funds from your overdraft account.
Peak flexibility  Withdraw what you need, when you need it.	Peak flexibility  Withdraw what you need, when you need it.
Transparent pricing  View the total, fixed cost of finance upfront before withdrawing and only pay for what you use.	Variable pricing  The amount you are overdrawn by depends on how much is in the account, meaning the cost of finance may be constantly in flux. You will also likely be charged a monthly fee to have this facility in place.
Online, paperless application  It takes just 2 minutes to fill out our simple application form online and approximately 24 hours to activate your facility.	Traditional application  Applying for any credit facility from a traditional lender typically entails time-consuming processes that can take weeks.
Free to apply  No application fees and no obligation to use the facility once approved.	May incur an application fee  Many overdraft facilities incur an application fee in addition to other costs, from establishment fees to penalties.
Early settlement rewards  Bridgement doesn’t charge early settlement penalties. In fact, we’ll give you a discount for settling your account earlier than planned.	Rewards may not apply  Because there are no set repayment terms, early settlement may not apply for overdrafts. You’ll simply pay interest on the amount borrowed until the account goes back above zero.

Bridgement’s business line of credit: all the speed and flexibility of a business overdraft without the variable costs 

For a short-term credit facility that offers both speed and flexibility to cover immediate cash flow gaps while offering fixed costs of finance, you might want to consider a business line of credit over a business overdraft facility. 

While we’re on the subject of speed and flexibility, Bridgement’s application process is 100% free, 100% paperless, and 100% commitment-free. It takes just 2 minutes to fill out our application online, and you can unlock access to up to R5 million in business funding in 24 hours or less.