An overdraft is a very useful thing to have. Here’s how to manage one.
Used correctly, an overdraft is a very useful tool for businesses of all sizes. Here’s how to manage one.
An overdraft is a credit arrangement with a bank allowing a customer to write cheques or make payments from the current account up to an agreed limit. It is a form of working capital finance.
An overdraft facility fee is often charged, along with interest on the amount of the (debit) balance on the current account, at an agreed rate.
- Managing your overdraft properly puts you in control. This means that you need up-to-date information. Ensure that you have registered your current account online with your bank. This way, you will be able to easily track the money going into, and out, of your account.
- Understand the charges and fees which may be applied to your overdraft. There are typical fees, such as:
Facility fee – This is a once-off fee for setting up your overdraft.
Renewal fee – This is only charged if you renew your overdraft at the end of the agreed term.
Referral fee – This is a fee the bank charges for each transaction made on your current account, when you are over your agreed overdraft limit.
Surcharge interest – This is extra interest that the bank will charge on top of the standard interest for the overdraft, if you exceed your agreed overdraft limit.
- Avoid paying by cheque as much as possible. Where possible, use online payments facilities instead. In most cases, it’s a lot cheaper to use online facilities,
- Ask your customers to pay you electronically instead of paying you by cheque. This will save you money and ensures you gain quicker access to your funds and potentially avoid the need for an overdraft (or at the least reduce the level of overdraft facility required).
- Never use an overdraft as a long-term borrowing facility. The interest rate for an overdraft is generally higher than for term lending, for example, so you should consider, carefully, the alternative ways of funding your business. Alternatives to an overdraft could include:
- Injecting more cash into the business
- Improved management of your debtor book
- Seeking increased terms from suppliers
- Other bank finance, including invoice discounting, asset finance and a term loan
Plan ahead: Keep your cashflow projections up-to-date and understand how your business’s financial needs may change in the period ahead. Stress-test your cashflow. For example, if your debtors take an extra 30 days to pay or if your creditors want payment up front, how will this affect your cashflow
Be cautious: Be realistic about how quickly you expect your customers to pay you. It’s better to expect slow payment and receive the cash more quickly. If you think that you will probably need access to more funding than your current overdraft limit, talk to your bank immediately.
Be proactive: If you do not have an overdraft, or if your existing overdraft limit is too low, contact your bank to discuss a suitable limit, on a temporary or permanent basis, based on the working capital needs of your business. Early contact will help you to avoid any potential embarrassment later, not to mention any additional charges, should an overdraft limit be breached.