A guide to business overdrafts

What a business overdraft is

A business overdraft is a facility attached to a company's current account that allows the balance to fall below zero, up to an agreed limit. It is designed for short-term, transient funding needs — bridging the gap between an outgoing payment and an expected receipt, for example — rather than sustained borrowing.

Overdrafts are typically reviewed and renewed annually. They are repayable on demand, meaning the bank can require full repayment at short notice. This distinguishes them from committed facilities such as a revolving credit facility, where the lender is contractually bound to provide funds for the facility term.

Cost structure

Interest is charged on the daily overdrawn balance, so the company pays only when it is actually in overdraft. Most banks also charge an arrangement or renewal fee, and some charge an availability fee on the agreed limit regardless of usage. Unarranged overdraft rates — where the account goes beyond the agreed limit — are significantly higher and should be avoided.

Because overdraft interest is typically quoted as an EAR (effective annual rate) applied daily, the actual cost for brief usage can be relatively modest. For longer-term or larger borrowing, the rate is generally less competitive than a term loan.

Limitations of an overdraft

The on-demand nature of an overdraft makes it unsuitable as a primary funding source for significant capital requirements. A bank can — and occasionally does — withdraw an overdraft facility at its discretion, particularly if the company's financial position deteriorates or a covenant is breached. Companies that rely heavily on their overdraft should consider whether a more formal committed facility would provide greater certainty.

Overdrafts also have limited amounts compared to other facilities. For more scalable working capital funding tied to actual receivables, invoice finance often provides greater headroom for growing businesses.

When an overdraft is the right tool

Overdrafts work well as a safety net for timing mismatches — where a company reliably expects receipts but faces temporary outgoings first. They are low-friction to operate once in place, with no drawdown process beyond spending from the current account. For companies with predictable monthly cycles and a need for a modest buffer, an overdraft remains a practical and cost-efficient solution.

Companies that find themselves permanently in overdraft — never returning to a positive balance — should review whether a longer-term facility better matches their underlying funding structure.