Guide to business overdrafts and other working capital products

Managing money is one of the biggest challenges a founder faces and getting to grips with working capital is essential for successfully operating a business, funding growth, and preventing it from failing.

Overdrafts and other working capital products are among the solutions to keep the cash flowing.

What is a business overdraft?

A business overdraft is a line of credit that allows you to withdraw more than the funds you have available in your business bank account.

It can be used as a safety net for unexpected expenses, short-term cash flow requirements, and funding issues, such as covering overdue payments from customers and settling invoices with suppliers.

The overdraft will have a limit agreed upon by your bank.

This can vary from a few hundred pounds to several million.

The limit depends on various factors, including your turnover and credit history.

You will be charged interest on the amount you borrow using a business overdraft.

This is typically higher than the interest payable on business loans.

You will also have to pay other fees and charges.

Business overdrafts can be secured or unsecured.

Secured means assets such as machinery or property will be used as security for the finance.

Unsecured overdrafts do not require security, which usually means higher interest rates.

The benefits of a business overdraft

There are several advantages of using a business overdraft, including:

• useful for dealing with short-term cash flow shortages
• a flexible form of lending as you only borrow what you need at a particular time
• usually quick and easy to arrange as your bank will already be aware of your business finances
• you pay interest only on the overdraft finance that you use.

The drawbacks of a business overdraft

You need to be aware of the disadvantages of using a business overdraft. They include:

• if you exceed your overdraft limit, you might be hit by high fees and charges
• the bank can ask you to repay the overdraft at any time, although this usually only happens if a business gets into financial trouble
• you can get an overdraft only from the bank you have a current account with, meaning you can’t shop around for a better deal
• most business overdrafts have a variable interest rate, making it hard to calculate your total borrowing costs
• you may have to pay an arrangement fee if you extend your overdraft.

Business overdraft fees and charges

You will be charged interest on the amount of money you use from your business overdraft, which will usually be calculated daily.

This means that the rates charged on overdrafts are typically higher than the interest you pay for business loans.

Other fees and charges you need to pay include:

• arrangement fee: an upfront fee charged by the bank for setting up an overdraft. It will be a set amount or a percentage of your overdraft limit
• unarranged overdraft fee: if you exceed your overdraft limit, you’ll be charged a penalty, and the interest due on the extra funding you’ve used may also be higher
• renewal fee: a typical charge for renewing the overdraft facility
• change fee: a fee for increasing your overdraft limit.

How to arrange a business overdraft

You can normally get a business overdraft only from the bank you have your business current account with.

Overdrafts can usually be arranged online, over the phone, or in branch.

To check that you meet the eligibility criteria, the bank will review your business as well as check your personal and business credit history.

You will have to explain why you need the overdraft and how you will repay it.

Alternatives to a business overdraft

If you can’t secure an overdraft, other options for managing your cash flow include:

Business loans

A business loan involves a lender providing money that is paid back, with interest, over an agreed period.

Loans can be secured or unsecured.

Secured means the lender uses property you own, such as your home, as security against the loan.

Unsecured loans don’t require security, so your business needs a good trading history to access one.

Secured loans of up to £125,000 are typically available.

Lenders usually won’t lend more than £25,000 in unsecured loans, although up to £40,000 can sometimes be accessed.

Due to a lack of trading history, it can be difficult for new businesses to secure a loan from a traditional bank.

Start Up Loans provides unsecured finance of between £500 and £25,000 to businesses that have not started trading or have been trading for up to 36 months.

Businesses that have already benefited from a Start Up Loan and have been trading for between three and five years might also be able to access a second Start Up Loan.

Credit cards

Business credit cards provide a line of pre-agreed credit that you can use to pay for things such as invoices, furniture, office supplies, entertaining clients, and travel costs.

You need a good business credit history to apply for a business credit card successfully, so it can be hard for the founders of new start-up businesses to get one.

You will need to pay interest if you do not clear your balance in full each month.

There will also be charges for missing payments and going over your credit limit.

You might also have to pay an annual fee.

Invoice finance

Also known as invoice discounting and factoring, invoice finance allows businesses looking for up to £1 million to use invoices as security for funding.

It can help with short-term cash flow issues by giving you quick access to finance without waiting for invoices to be paid.

Invoice finance is generally only available to established businesses with a trading history that can demonstrate the ability to repay the loan.

They also need to receive payment for invoices within 90 days and have customers with a good record of settling invoices on time.

Asset finance

This involves using business assets, such as machinery, equipment, and property, as security against finance.

Facilities of £1 million and over are typically available from specialist lenders and high-street banks.

You need to have a trading history and be able to demonstrate that you can repay the loan.