An overdraft or a line of credit is a revolving credit facility where you can use up to a predetermined limit set by the financial institution. It is a revolving credit facility as you can use a certain amount; pay it back and then use that portion of the loan again without going through another credit approval process. There is generally no fixed repayment requirements as long as the facility balance (after interest expenses is added) at the end of the month is below the facility limit. This is different from a business loan where there is a fixed repayment periodically and once you pay back the principal according to the repayment schedule, you normally cannot access that portion of the loan again without going through another loan application process.
What is a business overdraft?
A business overdraft is a feature of a business transaction account that allows funds to continue to be drawn once the account reaches a zero balance. An overdraft will have a pre-arranged limit which can be reached and paid back, and in this way it is often described as a type of Line of Credit (see below).
Most overdrafts are unsecured, especially where the limit is below $100,000, and have been approved based on the strength of the business’s financials.
What is a business line of credit?
A Business Line of Credit is usually a secured form of business loan. As such lines of credit have a higher limit than an overdraft and a lower interest rate. Like an overdraft there is a predetermined limit which the facility can be drawn to and paid back as funds become available.
While overdrafts are usually used to meet short term cash flow gaps and unexpected expenses, Lines of Credit are usually used to manage mid to long term seasonality, or used for investing, expanding, refinancing and covering larger operating expenses.
What are the benefits of a business overdraft / line of credit?
Business Overdrafts and Lines of Credit provide many benefits.
- Manage unexpected business expenses such bills, salaries and supplier invoices
- Tender for larger jobs and projects, knowing you have source of funds to pay for them
- Negotiate better terms and discounts with suppliers by providing larger upfront payments, or take advantage of special deals
- Only pay interest on funds drawn down, and there is no minimum or maximum that needs to be repaid
- The facilities are linked to a transaction account and can be accessed relatively quickly through internet banking, phone banking or in a branch
Which lenders can usually provide a business overdraft / line of credit?
Most of the major and second tier lenders who offer business financing have an overdraft / line of credit facility. Some boutique and private lenders also can offer overdraft / line of credit facilities.
Does property need to be provided as security?
No, property security is not compulsory. An overdraft can be unsecured i.e. borrowing against the company balance sheet without the use of a real property as security. However, security may be requested if required for credit approval or the limit is relatively large.
What are the costs associated with business overdraft / line of credit?
The costs involved with these facilities are:
- The interest rate, which is variable (fixed rates are not available)
- The Line Fee or Facility Fee – this is what the lender charges for having the funds in reserve, and available 24/7
- Establishment fee – a one off fee charged at the establishment of your overdraft.
As every business is different, these fees are based on how much you borrow, the strength of your business and the type of security provided.
Are there any restrictions on using a business overdraft or line of credit?
The funds are to be used for business purposes, and facility needs to be kept under the pre-agreed limit of or a penalty rate will apply. Apart from that, there are no restraints on the use of funds.
Common uses of these facilities include:
- Purchasing stock or inventory
- Funding marketing initiatives
- Funding payroll during slower periods
- Paying operating expenses
- Paying project expenses during construction or project delivery
- Paying unexpected expenses
- Paying bills while waiting for receivables
- Setting up a company or a new venture
- Covering a default of a major client
- Managing seasonality or other cash flow gaps
What information and supporting documents do i need to get approved?
Applying for a business overdraft or line of credit is similar to applying for any business loan. You will need to provide your:
- Identification Documents
- Business details – ABN and ACN
- Accountant prepared Financial Statements
- Business Bank Statements
- Evidence of security – if required
- You will also need to demonstrate clear credit history and all statutory payments and ATO liabilities must be up to date