Overdraft

An overdraft is an arrangement with a bank that lets a business withdraw more money than it has in its current account, up to an agreed limit. If the account holds £300 and the overdraft limit is £500, the business can spend up to £800 in total. Any amount spent beyond the £300 is borrowed and must be paid back, with interest.

It suits a temporary cash gap, when money is due out before customer payments arrive. For example, a mobile bike repair business has £300 in its current account but must pay £520 for parts and insurance before a busy weekend. An overdraft covers the £220 gap so the work can go ahead, then customer payments clear the balance.

Why businesses use one

• Quick to arrange — usually simpler than applying for a loan, especially for an existing bank customer.
• Flexible — the business borrows only what it needs, when it needs it, rather than taking a fixed sum.
• Protects cash flow — it covers short gaps between paying suppliers and receiving sales income.

The costs and risks

An overdraft is not free. Banks charge interest on the amount borrowed and may add arrangement or monthly fees, so the longer the balance stays negative, the more it costs.

The bank can also reduce the limit or ask for repayment at short notice. That makes an overdraft risky for a large, long-term purchase such as machinery or a shop refit, which needs finance that cannot be pulled away. It is best used for short-term needs and cleared as soon as possible.