Is The Overdraft Alive And Well? Part 2
In last week’s blog, I asked the question: “Is a bank overdraft still a good funding option for a business owner to consider?”
I made the point last week, that whilst there are now many funding options for business owners to consider, nevertheless, the bank overdraft is still very much a part of the overall funding solution for many business owners.
This week, I want to look in more detail at the security required for an overdraft, the costs involved and some of the pros and cons that an overdraft has to offer. So here goes.
When it comes to the security for an overdraft, much of the time, particularly on smaller overdrafts, the facility is completely unsecured. However, there may be times when the lender will require a personal guarantee from you as the business owner. In this situation make sure you know exactly what you are guaranteeing. Therefore, read the paperwork and if you feel it would be prudent, take some advice from your solicitor.
There are also times, particularly on larger overdraft facilities, where the lender in question will require some form of security. This security can take the form of assets within the business or as an alternative, the lender may require a charge on the personal assets of the business owner, such as their own home.
This being the case, again it is important to understand what you are getting into, as using your main residence as the security for any type of loan can have serious implications should you find yourself unable to meet your commitments.
Regarding costs, the main costs associated with an overdraft are as follows:
- An arrangement fee or set-up fee which is a one-off fee and is typically a percentage of the overall facility being arranged.
- An interest rate which is calculated daily and is based on the amount of the overdraft facility being used. Interest rates for overdrafts vary and are affected by whether or not the overdraft is secured.
- In addition, there is likely to be a monthly maintenance or service fee which the lender will charge as part of running and monitoring the overdraft. This is normally charged monthly.
As you can imagine, interest costs and fees vary a great deal depending on a number of factors, so my advice is to talk to your bank if you are thinking about an overdraft and discuss costs and charges with them.
One word of warning on costs. Avoid a situation where you have an unauthorised overdraft. This will mean both the interest rate and the fees being charged will increase dramatically, and if you are not careful can add up to a significant amount. As a result, an unauthorised overdraft is best avoided.
One of the advantages of obtaining an overdraft facility is that you will be required to provide minimal information. This is because you already have a business account with whichever bank you are with. As a result, they will have carried out all their KYC (Know your Customer) requirements when they first opened your bank account. In addition, they know how your bank account is being conducted as they can see it every day, and so they won’t need bank statements from you.
The only thing your bank might request is up to date audited or management accounts as part of putting the overdraft facility in place.
Also, as part of their ongoing monitoring of the overdraft facility, your bank may require accounts – audited and/or management – to be provided as they become available. Either quarterly, if it’s management accounts, or annually if they require audited accounts.
So, what are the other advantages and disadvantages of an overdraft facility?
- If the overdraft is to be unsecured or the bank only require a personal guarantee, they are generally quick to arrange and put in place – often a matter of days or a week at most. Obviously if the bank require security over other assets, particularly property assets, that can take longer to put in place.
- Once the facility has been agreed, funds are available immediately.
- Ideal for short term working capital requirements.
- Should you clear the overdraft, there are no early settlement charges for doing so.
- The amount of the overdraft facility can be tailored to your specific requirements and the needs of the business, which includes covering both day-to-day cash flow requirements with additional back-up against unexpected expenditure that may arise.
- Interest is paid only on the overdrawn balance.
- The lender may not grant the entire amount requested, as the business’s financial situation and in particular how the business bank account is conducted will be taken into consideration.
- Overdrafts are repayable on demand, although this is normally unlikely unless the business gets into financial difficulties.
- As with other types of debt, if the overdraft is secured and the business fails to repay, the lender may take action to seize the security provided for the facility.
- You may need to spend time preparing management accounts.
- As with all borrowing, failure to pay the interest charges on the dates due can lead to a reduction in your credit score, and the bank may also charge increased interest rates or fees as a result of your non-performance on the facility.
All that said, in answer to my over-arching question over the last two weeks: “Is the bank overdraft alive and well?”
I think the answer is, “Yes, it is”.
In my view, the overdraft remains part of the overall funding solution for many business owners, particularly when it comes to meeting the day-to-day working capital and cash flow requirements of the business.