Sources of Finance: Bank Overdraft

A bank overdraft is a common external and short-term source of finance for a business.

Comparison of Bank Overdrafts and Bank Loans

The key advantages of overdrafts and loans in certain business situations:

Advantages of an overdraft over a loan

• Business only pays interest when overdrawn
• Bank has flexibility to review and adjust the level of the overdraft facility, perhaps on a short-term basis
• Overdraft can be effectively be used as a medium-term loan – the facility is simply renewed each time the bank comes to review it
• Being part of short-term debt, the overdraft balance is not normally included in calculations of the business' financial gearing

Advantages of a loan over an overdraft

• Business and bank know precisely what the repayments of the loan will be and how much interest is payable and when. This makes cash flow planning more predictable
• The loan is committed – the business does not have to worry about the loan being withdrawn whilst it complies with the terms of the loan