Business overdrafts: everything you need to know

Running a business often means dealing with cash flow problems. That could be down to unpaid invoices, a slow trading period or an unexpected bill. Credit options such as loans or asset finance can help, but not every shortfall needs a long-term fix. That’s where a business overdraft can come in handy. Here’s what you need to know. 

Key takeaways

• A business overdraft gives you quick, flexible access to extra cash when you need it

• You only pay interest on the amount you use, not your full limit

• Banks can review, recall or cancel overdrafts, so check the terms and manage your use carefully

What is a business overdraft?

A business overdraft enables you to borrow money when your account balance falls short. It works like a personal overdraft – providing a buffer to cover costs as they come up. You only pay interest on what you use, not the total limit. So, if you have a £10,000 facility but use just  £1,000, you only pay interest on that £1,000. Some banks may also charge a fee for having an overdraft, so check your account terms.

You can repay the overdraft in full or in instalments, depending on your cash flow. But banks can ask for full repayment at any time, so it’s important to read and understand the terms before you go overdrawn. You can usually ask to adjust your overdraft limit if required – the bank bases its decision on a credit check carried out when you make the request. 

How does a business overdraft work?

A business overdraft is a relatively straightforward form of borrowing. It’s designed to be flexible and available in times of need. Here’s how it works:

1. Apply through your bank

Request an overdraft linked to your business account. The bank checks your credit score to decide if you qualify. If your business hasn’t built up any credit history yet, they may check your personal credit score.

2. Get a credit limit

If approved, the bank sets a borrowing limit based on your needs, your business’s finances and credit score. 

3. Borrow when needed

Use the overdraft when your account balance drops below zero, up to your pre-arranged limit.

4. Pay interest on what you use

Interest is only charged on the amount you borrow, not the full limit available to you.

5. Repay as cash comes in

Pay back the overdraft in full or in instalments, depending on your circumstances. Many banks charge fees while you use the overdraft. Factor these costs into your budget.

6. Stay aware of changes

The bank can review, change or cancel the overdraft with little notice, so check your account terms regularly.

The pros and cons of a business overdraft

You need to carefully consider the advantages and disadvantages of a business overdraft. Here are the main things to bear in mind before starting an application:

Pros

• Funds are available quickly – Use the overdraft as soon as your account dips below zero

• You can borrow just what you need – You don’t need to get excess credit to cover a small shortfall

• Interest is only charged on what you use – Avoid paying interest on unused credit

• Repayments are flexible – Pay back in full or in instalments, depending on cash flow

• Let’s you manage short-term gaps in cash flow – Cover unexpected costs or delays in payments without long-term borrowing

Cons

• Higher interest rates – Pay more interest than you might with a loan or business credit card

• Risk of sudden repayment demands – The bank can request full repayment with little notice

• Extra fees – Some banks charge setup or maintenance fees

• Limited borrowing – Overdrafts may have lower credit limits than other finance options

• Can negatively impact your credit rating – Misusing the facility can harm your credit score

How do you get a business overdraft?

To get a business overdraft, first check you meet the bank’s eligibility criteria. Each bank sets its own rules, but usually you need to:

• Be aged 18 or over

• Hold a business bank account

• Run a UK-based business

Once you satisfy the eligibility criteria, getting the overdraft should be relatively simple. Here’s what you need to do:

• Work out how much you need – Calculate the credit your business needs to cover shortfalls. Look back over statements to understand cash flow patterns, so you can plan accordingly 

• Compare options – Check overdraft limits, interest rates and fees across banks, because costs differ by provider. Check fees, in particular, because some banks may charge for arranging the overdraft, renewing it every year, increasing or reducing your limit, or for unauthorised use if you go over your limit

• Apply through your bank – Complete the application online or in branch

• Submit your business info – Share accounts, cash flow forecasts and bank statements along with anything the bank requests to help with your application 

• Get a decision – The bank runs credit checks and confirms your limit if you meet the criteria

What are the alternatives to business overdrafts?

There are plenty of alternative business finance options if an overdraft doesn’t meet your requirements. Here are a few of the more common options, and how they work.

Business loan 

A business loan lets you borrow a fixed amount and repay it over a set term, with interest. Best for larger, one-off costs.

Business credit card 

Pay for short-term costs or everyday spending with a business credit card. Only pay interest if you don’t clear the balance each month.

Invoice finance 

Sell unpaid invoices to a lender and get cash up front, minus a fee. Invoice finance can be particularly useful if you have clients who regularly fail to pay on time.

Asset finance 

Pay for assets such as machinery, raw materials or stock in instalments, without buying them outright in one go.