Introduction

We previously covered What is an Overdraft Facility? This article focuses on the advantages and disadvantages associated with using a business overdraft in your business operations.

Business overdrafts are lines of credit that become available from your bank when a withdrawal is made that exceeds the balance in your business debit account. Essentially providing you with the ability to continue making withdrawals despite the account being nil. The purpose of this function is to provide flexibility in your cash flow. Naturally, what you spend needs to be repaid at interest and there is a limit similar to a credit limit. This line of credit can be either secured or unsecured depending on the conversation with your bank. On the basis of this conversation, it may be advisable to consult an Asset Finance Lawyer to understand what assets may be part of the secured

Advantages

  • Good for seasonal businesses as they need to cover short-term cash flow shortage
  • Only pay interest on the funds you withdraw
  • Avoid getting bounced cheque/payment fees if you don’t have enough funds in your business bank account
  • Can apply for an overdraft at any time
  • You can choose to close the overdraft facility at any time, even during the fixed period of your business loan
  • Often the bank won’t complete an annual review of your overdraft if you’re business loan is for less than $1 million and you’re trading within the limit

Disadvantages

  • Another form of credit, attracting interest, fees & charge. In fact, the interest rate is a higher interest rate than the business loan itself
  • Having an overdraft facility can provide an unrealistic sense of security if your business is genuinely suffering from regular ongoing cash flow & liquidity problems
  • If you go over the limit, you can incur significant penalty fees
  • You and your assets can be personally liable if you can’t repay the amount you withdraw from the facility
  • The facility can be just as quickly closed down by the bank if you breach the terms & conditions of the facility

Conclusion

Business overdrafts are an option available for your business when cash flow is tight. However, bear in mind that business needs may change over time. It is worth reviewing your options regularly with a business lawyer. This conversation with your business lawyer should focus on what is needed for the business in the short-term as it is not advised to use business overdrafts long-term for continued smooth operations.

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Abhinav Parashar

Abhinav is a legal intern at LawPath as part of the content team. Currently in his 3rd year studying a Bachelor of Laws at Macquarie University (Major in Banking, Corporate, Finance & Securities Law). He is keen to learn more about Mergers & Acquisitions in the future.