Business Loans

The Pros and Cons (and Alternatives) of a Business Overdraft

May 2024 • 6m

Jordan Leighton

Head of Partnerships, Bridgement

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If you’ve ever used an overdraft facility on your personal account, then you’ll have a good idea of how a business overdraft works. This fast, flexible, short-term credit facility is great for covering unforeseen expenses and cash flow gaps on short notice.

However, there are other equally fast and flexible funding options available to businesses that do not incur the same variability of costs as a business overdraft. We wrote this handy article to explore the pros and cons of a bank overdraft for your business, as well as an informative comparison with a favourable alternative.

What is a business overdraft?

A business overdraft facility is a short-term credit arrangement between a business and a bank that allows the business to withdraw from the account even when there are zero funds in it. Functionally, it serves as a safety net, allowing businesses to “overdraw” on the account balance to cover cash flow shortages at a moment’s notice.

There are two types of business overdrafts: authorised and unauthorised. An authorised overdraft is arranged beforehand with the bank and typically incurs lower rates. An unauthorised overdraft is when the business spends more money than there is in the account without arranging it beforehand, which results in higher fees. Business overdrafts are not designed for long-term use. They are subject to the bank’s terms and conditions, including the possibility of termination or the bank “calling in” the overdraft on short notice.

How does a business overdraft work?

Businesses can apply for an overdraft facility with their bank. Typically, the process involves a review of the applicant’s turnover and credit history, which can take some time to complete.

Once the business has successfully applied for an overdraft facility, it can continue transacting on an “empty” account — effectively borrowing against accounts payable but through the bank. The amount borrowed from the overdraft facility will incur a range of charges, including interest, arrangement fees, and penalties for exceeding the limit.

Businesses typically use overdraft facilities to cover short-term expenses such as purchasing extra inventory to meet a spike in demand, paying for repairs, settling invoices that are close to being overdue, and bridging cash flow gaps when incoming payments are delayed.

Pros and cons of a business overdraft facility

The primary appeal of the business overdraft is its accessibility. Businesses can keep running even when there are technically no funds in the account and, once the overdraft has been approved, businesses don’t have to wait to borrow funds. However, other aspects of the business overdraft make it a less sustainable borrowing option. It comes down to your cash flow needs.

Pros of a business overdraft facility

Convenience
Businesses are under no obligation to use the full amount of the overdraft
A flexible funding option without a set repayment schedule

Cons of a business overdraft facility

It can be tricky to know the true cost of finance, especially if funds are constantly coming in and going out of the account (which puts the amount you are overdrawn in constant flux)
Businesses often have to pay fees on the full amount of the overdraft facility, even if they only use a fraction of it
Incurs a range of costs including annual or establishment fees (the bank’s “insurance” for going below zero) as well as interest rates and penalties for exceeding the limit
Banks can demand the full settlement of the facility at any time

What are some business overdraft alternatives?

If your business is looking for flexible financing options that are quickly and easily accessible to cover cash flow gaps, there are alternatives to business overdrafts available. Many alternative financing options offer a more intentional approach to borrowing, providing speed and flexibility with more stable and sustainable terms. For flexible short-term borrowing, we’d recommend a business line of credit.

Business overdraft vs. business line of credit

A business line of credit is similar to a business overdraft in that they are both short-term credit facilities, the limit of which is predetermined so that the business can borrow any amount it needs at short notice. However, a business line of credit represents a more intentional approach to borrowing and typically incurs more transparent and lower financing costs, which can be more sustainable for businesses in the long term.

Bridgement business line of credit	Business overdraft facility
Instantaneous access Access your credit facility online 24/7. Request and receive funds in a matter of minutes.	Instantaneous access Quickly request and receive funds from your overdraft account.
Peak flexibility Withdraw what you need, when you need it.	Peak flexibility Withdraw what you need, when you need it.
Transparent pricing View the total, fixed cost of finance upfront before withdrawing and only pay for what you use.	Variable pricing The amount you are overdrawn by depends on how much is in the account, meaning the cost of finance may be constantly in flux. You will also likely be charged a monthly fee to have this facility in place.
Online, paperless application It takes just 2 minutes to fill out our simple application form online and approximately 24 hours to activate your facility.	Traditional application Applying for any credit facility from a traditional lender typically entails time-consuming processes that can take weeks.
Free to apply No application fees and no obligation to use the facility once approved.	May incur an application fee Many overdraft facilities incur an application fee in addition to other costs, from establishment fees to penalties.
Early settlement rewards Bridgement doesn’t charge early settlement penalties. In fact, we’ll give you a discount for settling your account earlier than planned.	Rewards may not apply Because there are no set repayment terms, early settlement may not apply for overdrafts. You’ll simply pay interest on the amount borrowed until the account goes back above zero.

Bridgement’s business line of credit: all the speed and flexibility of a business overdraft without the variable costs

For a short-term credit facility that offers both speed and flexibility to cover immediate cash flow gaps while offering fixed costs of finance, you might want to consider a business line of credit over a business overdraft facility.

While we’re on the subject of speed and flexibility, Bridgement’s application process is 100% free, 100% paperless, and 100% commitment-free. It takes just 2 minutes to fill out our application online, and you can unlock access to up to R5 million in business funding in 24 hours or less.

About the Author

Jordan Leighton

Head of Partnerships, Bridgement

Jordan is the Head of Partnerships at Bridgement. Having studied a Bachelor of Commerce (BCom) at the University of Pretoria, Jordan went on to work as both a Financial Advisor at Envestpro and a Business Development Manager at TecEx before joining Bridgement. His background in both advisory services, as well as business development, lends Jordan a natural finesse for strategy and a keen eye for identifying growth potential in small businesses, which serve him well in the facilitation of partnerships While no two days look entirely the same for Jordan, a typical day consists of SME outreach and communications, onboarding and clarification of processes for current clients and managing relations with partners who form part of Bridgement’s referral network. Helping prospective and current clients understand the value that Bridgement brings to their businesses and how best to leverage its resources is a key responsibility for Jordan in successful partnership management. He also assists in product innovation, development and implementation. As a small business owner himself, Jordan understands how fundamentally vital cash flow is to secure long-term growth and success. Equally important is the reality of how difficult it is as an SME to acquire this funding and support from traditional banks. Massive amounts of red tape and archaic procedures make it difficult, if not impossible, for smaller businesses to obtain cash flow, particularly if the minimum requirement is higher than what they need. This in-depth awareness and empathy drive Jordan to assist South African SMEs in building successful, lasting growth and development partnerships with Bridgement. Success, to Jordan, is when a client successfully applies for and receives the funding they need without delays or unnecessary complexity, and it’s a goal he’s achieved for more than 250 small businesses to date.