Having a cash flow crunch? An overdraft facility is a handy option but beware of the traps
An overdraft facility can be a great feature to have on your business loan because it allows you to cover shortfalls in your cash flow.
This is particularly the case with small business (SMEs) that deliver, sell or produce goods and operate on seasonal operating cycle.
Some lenders offer competitive interest rates on overdraft facilities and it can be an easy way to cover working capital requirements in your business. However, there are traps to be aware of so it’s important to consider all aspects of the facility before making a decision.
How to get approved
With an overdraft, you’re essentially spending “over” what you have in your business loan bank account at any given time.
Because of this, you have to prove to the lender that you can “service” or meet the overdraft repayments and show a business need for what is essentially another form of debt.
How do I qualify?
You have the option to apply for an overdraft facility as soon as your business loan is approved by the lender.
Generally speaking, you may qualify for an overdraft facility if:
- Your business turnover is solid: You’ll usually just need to provide your latest balance sheet and profit and loss statement (P&L).
- You have equity in an existing property to use as security: You can typically borrow up to 85% of the property value for business purposes. If you own the commercial premises that you operate from, you can also use that as security for the overdraft.
- You can show a legitimate business need: Banks generally want to see that the need for an overdraft is regular and ongoing rather than a one-off cost that you need to cover.
There can be many reasons why you need an overdraft facility and as specialist mortgage brokers, we can find you a lender that understands the needs of business owners.
For example, if you’re running a glass manufacturing business, you can provide financial evidence of the costs of producing a product and the time lag in actually receiving payment from a client.
Discover if you qualify!
Call us on 1300 889 743 or complete our free assessment form to speak with one of our business loan specialists.
Will the bank lend against my client book?
For accounting firms, barristers chambers and medical centres, some lenders may consider your client book or trail income as added security for the overdraft facility.
This would technically be considered an unsecured overdraft facility but you can avoid being charged a higher interest rate if you can also put a property that you own as security.
How much will the bank lend me?
As a general rule, you can get an overdraft facility of up to $100,000 unsecured which is usually enough if you’re running a small business.
Do you need more than this?
The maximum amount the lender will offer you really depends on your business needs and how much security you can provide.
If you’re a cabinet maker, for example, you’ll usually need a bigger overdraft than someone working in a service business such as accounting.
Your costs to produce a complete kitchen are simply higher while a service business inherently has fewer costs.
It’s the reason why most lenders are wary when it comes to extending overdraft for service businesses: it’s usually a sign of distress.
If your sales aren’t going up, you’re paying the same costs for stock and employee wages, the bank will be asking why you need a bigger facility.
Is there a minimum limit?
There are some lenders that offer overdraft limits of as little as $2,000.
In saying that, if you need less than $20,000 to inject into your business or to cover outstanding debt, it may be worth getting a business credit card instead.
Is the interest different to your business loan?
Like getting a line of credit for your home loan, the interest on an overdraft facility is usually slightly higher than your business loan.
In addition, the interest rate is always variable unless you have a strong business turnover and are using the facility on a regular basis, in which case you’re likely in a position to negotiate a fixed rate.
We can help!
We have a range of lenders to choose from and strong relationships with key decision makers.
Let us help you find a business finance solution that works for you and at a great price.
Call us on 1300 889 743 or complete our free assessment form to speak with one of our mortgage brokers.
The pros and cons of overdraft facilities
An overdraft facility can work wonders for your business if you use it in the right way.
Although it’s a feature that comes with business loans, it’s important to keep in mind that it’s another form of credit with its own interest and fees.
- It’s good for business owners that operate on a seasonal basis and need to cover short-term cash flow issues.
- You only pay interest on the funds you withdraw.
- With an arranged overdraft facility, you can avoid getting bounced cheque fees if you don’t have enough funds in your business bank account. Interest on accidental overcharges can be up to 30% or even higher.
- You can apply for an overdraft at any time.
- As a revolving facility, you can also choose to close the facility at any time, even during the fixed period of your business loan.
- The bank won’t complete an annual review of your overdraft if you’re business loan is for less than $1 million and you’re trading within the limit.
- It’s another form of credit, attracting interest, fees and charge. In fact, the interest rate is higher interest rate than the business loan itself.
- Having an overdraft facility can provide an unrealistic sense of security if your business is genuinely suffering from regular and ongoing cash flow and liquidity problems.
- If you go over the overdraft limit, you can incur significant penalty fees.
- You and your assets can be personally liable if you can’t repay the amount you withdraw from the facility.
- The facility can be just as quickly closed down by the bank if you breach the terms and conditions of the facility or even the covenant reporting requirements of the overall business loan.
What if I don’t use the overdraft?
Because the bank is putting aside capital for the overdraft, it’s actually costing them money.
So if you don’t use the facility, you can be hit with a massive fee.
As a mortgage broker, we can provide regular business loan health checks and let you know whether you risk being charged a fee for an unused overdraft facility and whether you would like to close it down.
Complete our free assessment form if you’re thinking about getting an overdraft to cover working capital in your business.
By properly assessing your situation, we can suggest a few different finance solutions that best suit your business needs.
Golden tips and FAQs
Overdraft facilities can be quite a flexible finance option and a mortgage broker can help you set up the facility so it best supports your business needs.
Of course, there are alternatives to an overdraft that you may want consider.
What is the repayment schedule on an overdraft?
The repayment cycle on overdraft facilities can be quite flexible, with most lenders offering monthly, quarterly or half yearly terms.
You can even roll bills on a daily or weekly basis!
The other thing to keep in mind is that you can choose to pay your interest monthly and pay your principal reductions on a 3-month basis.
It really depends on how you manage your business financials and if you can choose a lender that really understands your business model and is willing to work with you.
Bear in mind, that lenders have the right to ask for payment of the overdraft in full if you’re business loan is in arrears.
In theory, you should be in debt for 15 days of the month and go back to credit for the remaining 15 days.
Banks have systems to work out what your operating cycle should be and quickly identify if your business is in distress.
What can you use the overdraft for?
Officially, you should only be using the overdraft for business purpose although borrowers do sometimes withdraw money for personal use.
We wouldn’t recommend doing this since it essentially breaches the terms of the business loan and the overdraft facility.
In saying that, you won’t necessarily be required to provide a receipt of every transaction made via your chequebook.
However, if you’re over the overdraft limit or you’re in arrears then your bank will likely delve deeper into each transaction.
Should I get a business credit card instead?
As mentioned previously, a business credit card may make more sense than an overdraft facility if you need anywhere between $10,000 and $20,000 for business purposes.
The main reason is that it’s typically a quick and easy approval process. You simply don’t need to provide a lot of financials to apply.
In fact, as long as you’ve been in business for at least 2 years, you can simply self-declare income with some lenders.
Secondly, you can get a very similar interest rate to an overdraft facility because you only need a small amount of finance for your business.
Finally, you have the option to sell the frequent flyer points!
Do you have other finance options?
The main benefit of the overdraft is to cover cash flow problems but what if you require business finance for other purposes?
Are you buying equipment?
Equipment finance may a cheaper option for you if you need to borrow funds to buy anything from a car, truck or forklift to medical equipment, industrial machinery or an excavator.
From purchase to commercial hire lease, there are a number of options to choose from so you find a solution that’s most affordable for your business needs.
Are you expanding?
Whether you need significant capital requirements to buy a new freehold commercial property or extend your existing premises to accommodate new staff or inventory, a commercial property loan may be a better option for you.
Firstly, you can borrower a lot more (up to 80% for a standard commercial property) and, secondly, you can usually get a cheaper interest rate.