Business Overdrafts Explained
Virtually everyone in the UK has either been offered, or is at least familiar with, the basic concept of an overdraft. After all, as consumers we’re typically offered personal overdraft products by our banks when reaching adulthood.
Business overdrafts work in a very similar way; allowing you to draw out more than your current debit balance with an understanding that you’ll repay any money borrowed (with interest) in due course.
There are, however, often more eligibility checks, complex terms, and robust risk assessments associated with business overdrafts compared to their consumer equivalents. In this article, we’ll dive into exactly what those differences look like.
What is a business overdraft?
Quite simply, it’s a short-term lending facility that a business can utilise. A bank or alternative lender may offer an overdraft product, set terms associated with it, and businesses will typically use these products to give a quick boost to cash flow or working capital.
The relatively low quantities of money that can be borrowed through a business overdraft, both in terms of how much you withdraw and the total facility limit, make it ideal for borrowing at frequent intervals to solve low-cost problems. You’ll find no fixed repayment intervals, unlike with a business loan product, essentially making an overdraft a revolving credit facility.
What terms are associated with business overdrafts?
Given that a business’ account can move from credit to debit often, interest on overdrafts is charged daily. Lenders and borrowers alike enter into agreements that last up to around 12 months initially, although these can either be longer, or extended.
The formal offer of a lending agreement made by a bank or online provider will always be preceded by a risk assessment, in which you may be required to provide documents detailing your business’ financial history, assets, and growth strategy. This could involve a level of automation when applying for more innovative products, and the output of that risk assessment could impact the interest rates you have access to.
Business overdraft rates: what to expect
Interest rates themselves are set depending on the Bank of England’s base rate. When browsing overdraft products offered by different providers, you may find typical interest rates to be around five times the base rate, although this differs based on:
- Which lender you’re partnering with.
- The total size of your debt facility.
- The amount of insurance you’re able to offer against the overdraft.
Insurance in business overdraft agreements
Overdrafts work very similarly to business loans regarding insurance. You may find a variety of options in market which require no insurance at all, while some products may become substantially cheaper when security is offered.
In terms of security, your business’ assets are often the first point of call; this could include stock, or perhaps company vehicles and equipment.
For medium to large-sized businesses pursuing overdrafts, it’s possible that lenders will introduce a covenant. This is essentially a formal agreement between both parties around how debt will be managed. It could stipulate the purposes for which borrowed money can not be used, or it may set a threshold for the levels of debt a borrower can enter.
Beyond an interest rate, each business overdraft is likely to come with arrangement fees. The most common format for these fees is to take a flat percentage of the total facility (maximum amount borrowed).
If a business fails to pay off its debt, it’ll likely incur late payment fees that could stack up the longer the debt goes unpaid.
Are business overdrafts a good option in 2021?
Bank of England data indicates that the current balance of overdrafts drawn by SMEs in March 2021 amounted to around £8,495m. While this may seem an enormous amount, the data also indicates that this figure has decreased by around 60% in the last decade.
Bank of England SME Overdraft Lending Volumes
Why, then, is the total volume of money being lent to UK SMEs via overdraft facilities in decline? While some sharp declines can be attributed to specific events, such as the introduction of the BBLS/CBILS coronavirus loans schemes in 2020, one key reason could be the sheer volume of innovative, competitive finance products being offered in market today.
Challenging the overdraft
Our product at Rapid Cash, for example, allows you to borrow money against your unpaid invoices so that you can enjoy the key benefits of an overdraft, such as a reliable boost to cash flow, at a competitive rate.
It’s a new style of invoice financing that connects a NatWest bank account to your accounting software, before using automation to give you the choice of which outstanding invoices you’d like to borrow against. If you’d like to learn more about how we’re challenging the overdraft, visit our home page - or dive deeper into the world of business finance with our SME finance guide.
To be eligible for Rapid Cash you must be trading for more than 6 months, have an annual turnover of at least £100k and either be a Limited Company or Limited Liability Partnership in England and Wales. Additionally, you need to invoice other businesses and use one of the following digital accounting software: Xero, Quickbooks, Sage 50, Kashflow, FreeAgent and Netsuite.
Security and guarantee required. Product fees may apply.