Types of business finance

What is a business overdraft?

A business overdraft is a financing option for small businesses in Australia. As a line of credit, you can draw on funds when needed to help manage cash flow, cover unexpected expenses or take advantage of business opportunities.

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What is a business overdraft?

A business overdraft is a revolving line of credit facility used by businesses to ensure they have the funds available to cover short-term expenses. It allows businesses to access cash up to, but not exceeding, a predetermined credit limit, which helps provide flexibility over their cash flow.

Once approved for an overdraft, the business is able to draw down cash as needed, so if their funding requirements are regularly changing or they have inconsistent or lumpy cash flow, an overdraft allows them to smooth gaps without requiring further loans.

Interest is charged daily on the drawn funds, rather than on the entire amount, like with a term loan, which can make an overdraft facility a good backup to be used when there is a cash flow problem.

What is a business overdraft used for?

Overdrafts can essentially be used for any purpose where you would normally need to access cash — things such as paying wages, funding stock purchases or covering unexpected costs. They can be a useful tool for businesses to have in their financial arsenal, giving them flexibility and peace of mind to meet quick or unexpected funding needs, and are considered a general-purpose funding solution.

Business overdrafts may be useful for:

  • Helping to manage cash flow — particularly if that cash flow is uneven or seasonal.
  • Paying staff (whilst waiting for clients to pay invoices).
  • Short-term opportunities when cash is needed quickly and for a short time.
  • One-off unexpected operating expenses.
  • Business overdrafts are not suitable for:
  • Long-term capital expenditure (such as the purchase of machinery, equipment, vehicles or other large assets).
  • Everyday use (where there is little or no working capital in the business).

What are the different types of business overdrafts?

There are two main types of business overdrafts available to businesses in Australia:

1. Unsecured business overdrafts

An unsecured overdraft is ideal for businesses with a good credit history. Unsecured overdrafts do not require any security, which means they may be quicker to obtain than secured overdrafts.

2. Secured business overdrafts

A secured overdraft is backed by an asset, such as residential or commercial property. This means that if you default on the loan, the lender can take possession of the security asset to recover the outstanding amount.

How do business overdrafts work?

With an overdraft facility, the business has access to cash (through their linked business transaction account) up to an approved limit. This revolving line of credit allows the draw down of funds as needed, as long as the approved overdraft limit has not been reached.

Funds can be repaid and drawn as often as the business owner likes, which is what makes a business overdraft facility such a flexible cash flow management tool. For example, with a credit limit of $50,000, $10,000 can be drawn down for business purposes, leaving $40,000 available if needed. As the cash flow position of the business improves, they can make repayments which tops their credit back up to be drawn in the future.

Interest is charged on the funds in use, however, be aware that other fees apply, such as an account keeping fee or line fee (sometimes designed so you pay interest on the credit limit regardless of whether you access funds).

How much do business overdrafts cost?

The main cost of an overdraft is usually the interest charged on the funds drawn. The interest rate will vary depending on the lender and the type of overdraft facility.

In addition to the interest on funds utilised, most business overdraft providers will also charge an interest rate (line fee) for the privilege of having an overdraft facility. Some banks or financial institutions can also charge you a one-time establishment fee, which is charged when they set up your facility. Finally, if you exceed your agreed overdraft limit, most banks will charge an excess drawing fee. 

Depending on how you use the facility, the costs of an overdraft can add up to a significant amount each year — particularly for businesses that frequently exceed their agreed limit.

Typical business overdraft interest rates

Lenders may determine interest rates, fees and charges depending on the individual circumstances of your business. This makes it vital to compare the different rates on offer before taking out an overdraft. Generally speaking, overdraft interest rates are usually higher than on a business term loan.

Given the potentially high interest rates associated with an overdraft, it’s generally best to utilise the facility for short-term cash flow management rather than for long-term capital expenditure. For long-term capital needs, it's a good idea to consider other options, such as a business loan, which may be cheaper in the long run.

Who can get a business overdraft?

To be eligible for a business overdraft, lenders may require that the applicant has been in business for at least 12 months and has a good credit history. The business will also need to demonstrate that it has the capacity to repay the overdraft through either ongoing profitability or by having substantial assets to offer as security.

If you are a start-up business, you may still be able to get an overdraft, but the lending criteria may be stricter. The bank or financial institution will want to see a well-thought-out business plan with realistic financial projections and possibly an exit strategy.

To get a secured business overdraft, you will need to offer an asset as security. The asset can be your home, commercial or residential property, or even equipment.

With an unsecured business overdraft, you don’t need to offer any asset as security. However, the borrowing limit is usually lower than a secured business overdraft, often between $2,000-$100,000.

Most business transaction accounts have the option for an overdraft facility. If you're interested in utilising a business overdraft, it might be a good idea to check with your business account provider.

Advantages and disadvantages of a business overdraft

Table Example
Pros Cons
Speed and ease — it gives the business access to immediate financing and the ability to take advantage of short-term opportunities. Interest rates can be higher than other types of funding, such as a business loan.
Flexible term and no need for reapplication. Fees apply — even if you don’t use it, such as application fees, annual fee, late payment fees or line fee.
Safety net — it's there before you need it, only pay interest when you use it. Often subject to misuse. It's tempting to use it for ongoing working capital needs and larger expenses.
It can be secured or unsecured, so rates can vary depending on the business. Qualifying can be difficult. Lending criteria often includes security and a good record (strong cash flow, 3 years of financial statements).

How much can I borrow?

In Australia, the amount you can usually borrow through a business overdraft will depend on the strength of your business and your financial history. However, as a general rule of thumb, you can usually borrow up to 80% of the value of your eligible business assets for a secured business overdraft. For an unsecured business overdraft, the amount you can borrow is usually capped at $100,000.

Should I get a business overdraft?

As your business grows, you will likely need more working capital to meet expenses such as inventory, payroll and operational costs. If you are a small business owner in Australia, you may be wondering when to consider getting a business overdraft. While there is no one-size-fits-all answer, there are some general guidelines you can follow.

Generally speaking, you should only consider getting a business overdraft if you have a strong business case for doing so. That is, you should only borrow if you have a clear plan for how you will use the funds and a realistic expectation of being able to repay the credit.

Of course, it is important to weigh the costs and benefits of any borrowing decision, and a business overdraft should be no different. Ultimately, the decision of whether or not to get a business overdraft should come down to your specific circumstances and financial goals. If you have a strong plan for how to use the funds, an overdraft may be a helpful tool for your business.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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