Understanding overdrafts

Understanding overdraft facilities

 All businesses have bank accounts and provided you have made regular deposits into your business' bank account, you might be able to request that an overdraft facility is linked to this account.  

This means the bank will allow you to use money you don’t have in order to operate your business. The moment your account goes into overdraft you will see your balances reflected as a minus e.g.  – R2,000. Given that you are using the bank’s money to operate your business, you must expect to pay for this service.

How banks approve overdraft applications

Bear in mind that banks make their money from lending money to individuals and businesses, and charging for administration costs and interest fees on the amount of the loan. So, they will examine your trading history to see whether they believe you can afford to have an overdraft.  

These are the types of things they look for:

  • Regular deposits: A regular flow of deposits coming into your business bank account.
  • Good money management: This means, they will check that you are being careful with your funds and not overspending, and, more importantly, that you are paying your bills regularly.
  • Good credit history: Banks will check your credit records to make sure that you do honour your debts.

Based on this information, they will decide to approve or not approve the application. Their investigation into your business account will also be used to determine the amount of money you will be able to access via the overdraft facility.

If your business has applied for a large overdraft limit, the bank may perform a  due diligence on your business before making a decision. Their aim is to be sure that the business can repay the overdraft. 

Depending upon the amount of the overdraft, they may require you to secure this loan. This means you might need to cede a valuable asset to the bank so that if you are unable to repay the monies, they can sell the asset and be confident that they will not lose their funds. If you aren’t sure how collateral works, then please read the module Learn more about collateral.

How an overdraft works

The interest rate on an overdraft is always linked to the prime rate, so be sure to review it annually. The interest on the amount you’ve overdrawn is calculated on a daily basis. This is then charged to your business at the end of each month’s cycle. 

Other costs to consider on top of the interest payment are:

  • An initiation fee.
  • A monthly admin fee.
  • An annual review fee.
The bank will monitor your account as they don’t want to see it permanently in overdraft. Their expectation is that your balance will fluctuate as income is deposited into the account, and this should definitely mean that there should be more times that the account is reflecting positive balances than when it is in overdraft. Something to consider is that a bank can recall an overdraft with virtually no notice, especially if they feel you are putting them at risk. This is usually done in small amounts so that the limit decreases a little each month.  Another course of action would be to convert a portion of the overdraft into a term loan, to enforce a gradual decrease of the debt.

Some banks have a new rule when it comes to overdrafts. If they offer you an overdraft facility that you aren’t using, they may charge you for not using it. Banks have started doing this because it costs them money to manage an overdraft.
