Overdraft

In plain terms

A business overdraft lets a company spend more than the balance in its current account, up to a pre-agreed limit. It's a buffer: you dip into it when money goes out before money comes in, and you repay it as receipts land. Interest is charged only on the amount you're actually overdrawn, day by day — not on the whole limit.

Overdrafts are a form of revolving credit: the facility replenishes as you repay, so you can use it again and again without reapplying. They're designed for short-term, fluctuating gaps rather than for funding a large one-off purchase, which suits a term loan better.

Why it matters to your business

An overdraft is a classic tool for smoothing cash flow. Because you only pay for what you use, it's efficient for covering brief, unpredictable shortfalls — a payroll run that lands days before a big customer pays, say. Used well, it's a safety net that keeps trading smooth without committing you to fixed repayments.

The catch is that traditional overdrafts have become harder to obtain and are often repayable on demand — the bank can reduce or withdraw the limit, sometimes at short notice, which is risky if you've come to rely on it. Charges can also mount: arrangement fees, renewal fees and higher rates for unauthorised excess. That's why many directors now look at dedicated overdraft alternatives that offer similar flexibility with clearer terms.

A worked example

A consultancy has a £25,000 overdraft limit. Most of the month its account is in credit, but each month-end it pays salaries before client invoices clear, dipping £18,000 overdrawn for about ten days.

It pays interest only on that £18,000, only for those ten days — not on the full £25,000 limit, and not for the whole month. Once invoices are paid the account returns to credit and no interest accrues. That pay-for-what-you-use efficiency is the overdraft's strength. The risk would be a quarter where invoices land late and the company brushes its £25,000 limit — at which point unauthorised-overdraft charges, or a sudden review by the bank, could bite. (Illustrative figures.)

Modern alternatives

If you want overdraft-style flexibility without the on-demand uncertainty, several options behave similarly:

• Revolving credit facility — a pre-approved limit you draw and repay at will, often with clearer terms than a bank overdraft. See our guide.
• Flexible working-capital facility — such as Credicorp Flex, where you draw what you need and pay for what you use.
• Invoice finance — releases cash tied up in unpaid invoices, smoothing the same gaps an overdraft covers. See our guide.

Each suits a different pattern of need. The right choice depends on how often you dip in, how predictable the gaps are, and how much certainty you want over the limit staying in place.