Whilst some businesses prefer to make use of a bank overdraft, there are a number of disadvantages of using this method of credit. Use this checklist to see whether an overdraft is right for your business.
According to Cash Resources, some disadvantages of a bank overdraft include:
- Many think it is set and forget, however if the business is growing it may have to be rearranged regularly, incurring new set up fees. Perhaps during the term of the facility.
- It is “at call” and can be called in by the lender at any time.
- You face administration fees if you exceed the agreed limit.
- Overdrafts are normally secured against business assets – the lender can take control of these if you don’t repay the overdraft.
- You can only get an overdraft from the bank where you maintain your current account. In order to get an overdraft elsewhere you need to transfer your business bank account.
- The interest rate applied is nearly always variable, making it difficult to accurately calculate your borrowing costs.
Banks typically set and limit business overdraft levels based on a company’s trading history, without recognising the true value of a company’s liquid assets.
Cash Resources suggests businesses realise this makes an overdraft backward looking and a potentially rigid way of financing growth, with the worrying disadvantage that it could be withdrawn at anytime.
Consider debtor finance
An alterative business funding option is revolving debtor finance, such as an invoice discounting facility that grows with a company’s sales and is only constrained by the level of invoiced business transactions. Invoice finance is therefore an asset-based facility, which can accommodate business expansion, typically giving fast access to cash up to 80 percent of outstanding trade debts.
Cash raised in this way can be used to reduce or complement an overdraft facility, but more importantly maintain cash flow or working capital and give the company the opportunity to achieve supplier discounts through early payment.