In a nutshell, an overdraft (OD) is a standby credit facility that allows people (businesses in particular) to withdraw cash from the current account up to a certain limit. It is usually up to 12 months and renewable annually, and repayable on demand thru the bank at any time. Any repayment into the od account can be withdrawn again so long as the total outstanding amount is within the OD limit. This is also why it’s called a “revolving credit facility.”
Since overdraft borrowing limits are typically lower than with a loan, an overdraft is perfect for short-term borrowing. For instance, if you need to pay for emergency facility maintenance or pay your staff until profits came through.
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When should a business consider overdraft?
Business overdrafts are good if a business is experiencing any of the following:
- Businesses that have lumpy cashflows, for instance, contracting businesses where employees are being paid weekly, but customers usually pay after job completion or after certain dates
- Funding general working capital. Includes meeting the timing gap between company expenses and customer payments
- Situations where added cash is required quickly and for a short time frame. For example, when a business needs facility troubleshooting or has the opportunity to purchase discounted stock
- Meeting occasional unexpected operating expenses, aiding with cash flow during periods when business is slow (for example, the existing COVID-19 pandemic or the Christmas/New Year holiday some businesses)
How to choose between secured and unsecured overdrafts
Business overdrafts can be availed both via secured and unsecured lending. What you choose will depend on your current circumstances, funds, and needs.
An unsecured overdraft means that pledging any assets (collateral) is unnecessary to finances to obtain the facility. On the other hand, a secured overdraft requires you to commit certain assets, including residential, commercial, and industrial property, to obtain a line of credit. Each of these offers advantages and disadvantages.
Unsecured overdrafts will expose you or your business to limited risk, but the line of credit will be smaller. Secured overdrafts let you access a much larger maximum loan amount. However, your bank requires you to commit assets, plus they’ll get rights to sell the assets you’ve put up as collateral if you can’t repay debts on your secured overdraft.
Finding the right overdraft facility that fits your business will depend on multiple factors, so you must assess your needs internally, do your research, or consult with a specialist adviser before making a decision. If you’d like to know more about overdraft requirements, overdraft interest, or process, simply go to a banking website like DBS, which offers a convenient online application.
Lastly, make sure to develop a repayment plan in place if you ever obtain this facility and that you’ll be able to afford monthly payments each month. Failure to keep up with your repayments will negatively affect your credit score, cost you your assets in the case of a secured overdraft, and even affect your ability to get approved for credit again in the future.