What is an overdraft?
Most people will understand that if you have a bank account it will normally have a zero or overdraft limit attached. Overdraft means you are taking more money out of the account than it has available, going into ‘negative territory’.
It allows you to borrow more money through your current account that what you have inside it. There are two types:
Authorised overdrafts are usually arranged in advance with your bank or lender. You operate at an agreed cost, but it will be much cheaper than an unauthorised overdraft.
Unauthorised overdraft means that you did not set up an agreement before drawing more money out than is allowed. As it has not been provided for, hefty fees and charges will be charged, for exceeding the authorised level.
Does your business need an overdraft, and can you get one!?
An overdraft should really only be used as an emergency funding situation or to cover exceptional payments. For example, the quarterly payment of VAT or rents for your business premises.
So, if your business is always in an overdrawn position, it may be time to look at other forms of finance. We are sure that the bank will be encouraging you to do this too.
Generally, banks prefer not to give overdrafts because they have to provide for capital that may or may not be used. This uncertainty means the banks charge more for these facilities than fixed lending or term loans.