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Study Notes

Sources of Finance: Bank Overdraft

AS, A Level
AQA, Edexcel, OCR, IB

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  • The loan is committed – the business does not have to worry about the loan being withdrawn whilst it complies with the terms of the loan

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