All maxed out: A business overdraft can be a quick solution for SME owners who find themselves facing unexpected cashflow issues. Photo credit: Unsplash
If you are frequently in need of funds to tide over cashflow crunches for your business, you may want to consider getting a business overdraft.
Depending on how you use it, it can be a viable, albeit short-term, solution for SMEs that want a pool of funds to use as and when they need it.
It can offer quite a lot of flexibility to cash-strapped SME owners who often need funds urgently and at little notice, for instance, to finance their payrolls.
A business overdraft (OD) is essentially a standby revolving short-term (usually a year) credit facility.
When a bank approves your business overdraft application, it is allowing you to withdraw funds or issue cheques from your current account up to an agreed limit at an agreed interest rate.
Once you use the funds, you can top it up again when funds have been made available to you. You can then withdraw the funds again. You can do so repeatedly as long as the outstanding amount does not exceed the OD limit.
Business overdrafts can be personal or for business, and can be secured or unsecured.
For secured overdrafts, you need to pledge collaterals such as bank deposits, property or shares to the bank.
If you are unable to repay your debts, the bank may sell your assets to recover the amount owed. If that still does not cover the amount owed, you will have to pay the difference.
As for unsecured overdrafts, the bank can grant you an unsecured credit of up to 4 times of your monthly income as long as you earn at least $30,000 per year.
An OD facility is usually renewed on a yearly basis. But do note that the bank has the right to demand that you repay the OD facility at any time.
You will be only charged on the amount you use. The interest is calculated on a daily basis, and debited from your account at the end of the month.
Apart from the interest, there is no repayment since an OD is a revolving credit facility – as long as the outstanding balance is within the available limit.
If you do not pay the interest, it will be added to part of the principal and snowballed over to the next month.
If you issue a cheque that exceeds the OD limit, your account is then described as having gone into excess.
The cheque will not be processed as you have insufficient funds to pay for it. You will also have to pay the returned cheque charge.
You need to repay this amount immediately, or you may have to pay a penalty interest rate.
This is charged on the excess amount, and is most likely higher than the OD’s agreed interest rate.
If you are still unable to pay the excess amount, the bank may demand that you pay the outstanding amount within a given period.
In some cases, the bank may stop or withdraw the OD facility completely. The latter will have an adverse impact on your credit score.
Unlike a standard term loan, a business OD has no fixed loan tenor. However, the interest rate is usually higher than that of a term loan.
A term loan is only disbursed once in full; while the funds in an OD facility can be repaid and reused many times – as long as the outstanding amount is within the OD limit.
However, as mentioned, the bank can demand that you repay the OD facility at any time. Some banks may also charge an annual overdraft fee.
That said, an OD facility does afford you the flexibility of repaying however much you can manage and then using however much you want to at any point in time – as long as you have made some form of repayment prior.
Some banks may also allow joint applications, in which case the responsibility of the debt will be shared by two parties.
Whether or not a business OD works for you depends on your repayment behaviour, or in other words, how timely you are with your payments.
As long as you are able to make some form of repayment, you can continue withdrawing funds from the OD.
You should also ensure you are able to pay the monthly interest with relative ease.
It also pays to be mindful of the risks involved if your account goes into excess and you are unable to pay back the outstanding amount during the deadline stipulated by the bank.
Bear in mind you also risk losing your assets if you had opted for a secured business overdraft.
In the broad scheme of things, while an OD can be a quick solution for an unexpected but urgent cash crunch, it is best reserved as a last resort.
SME owners would do well to improve their planning and make strategic business decisions so they can avoid getting caught off guard with unexpected cash crunches, and hence being forced to opt for an OD.
If you often find yourself in need of funds, you may want to consider getting a short-term loan instead.
That said, an OD can be a good standby credit facility that you can dip into in case of any emergencies – as long as you are mindful of its limitations.
Belinda loves thinking about random stuff, and collecting useless bits of facts and trivia. She often roots for the underdog, and believes the world needs more happy endings.