Business overdraft: how it works and what happens at review

How a business overdraft works

Your bank agrees a limit on your business current account, say £60,000. Payments out keep clearing when the balance goes below zero, until you reach the limit. Money paid in reduces the overdrawn balance straight away. Interest is worked out on the overdrawn balance each day and charged monthly or quarterly, and there is a fee for arranging or renewing the limit.

Nothing is drawn by notice and nothing is repaid by instalment. The account moves in and out of credit with your trade, which is why an overdraft suits a business whose takings and payments do not line up week to week: wages go out on Friday, customers pay on the following Tuesday, the VAT falls due a few days before a large invoice is settled.

Going over the limit, or overdrawn without one, is expensive. Banks charge a higher rate or a fee on unarranged borrowing and may return payments unpaid. A returned payment to a supplier or to HM Revenue & Customs costs more than the fee: suppliers tighten their terms and a missed tax payment carries penalties.

An overdraft is a business bank account product, so you apply to the bank that holds your account. Some lenders offer revolving facilities that work in a similar way without moving your bank account, and a funding search through Swoop shows those alongside other working capital options.

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Repayable on demand

Banks’ overdraft terms make the overdraft repayable on demand. The bank can reduce the limit or ask you to clear the balance at any time, including in the middle of the year, and it does not need you to have broken any condition first. In practice a bank asks for repayment when it sees a reason: losses in your latest accounts, an account that never comes back into credit, a county court judgment, a change in the bank’s own lending policy for your sector.

If your bank turns down an application for finance, including a new or larger overdraft, and it is one of the nine large banks designated under the Small and Medium Sized Business (Finance Platforms) Regulations 2015, it must offer to pass your details to designated finance platforms that share them with other lenders. Your details go only with your consent.

If the limit is cut or withdrawn, ask for the decision and the reasons in writing, ask for time to repay, and start looking for a replacement facility at once. Lenders reading your application will ask why the bank withdrew, so have the answer ready with up-to-date management accounts.

What happens at the annual review

1
The bank asks for figures
Your latest filed accounts, management accounts for the year so far and sometimes a cash flow forecast. Send them before the renewal date so the limit does not lapse while the bank waits.
2
It reads how the account has run
How often you went over the limit, whether the account came back into credit during the year, and whether the overdrawn balance has been creeping up month by month.
3
It makes an offer
Renewal at the same limit, a renewal with a lower limit or higher pricing, a limit that steps down over the year, or a request to move the borrowing onto a loan.
4
You accept or refinance
Accept the offer and pay the renewal fee, or use the time before the renewal date to arrange a different facility with another lender.

What an overdraft costs

Illustrative example

A company with a £60,000 limit that is overdrawn by an average of £25,000 for 200 days of the year and in credit for the rest. The rate and fee are assumptions for the arithmetic: each bank sets its own.

Interest on £25,000 for 200 days at an assumed 12% a year: £1,643.84
Annual arrangement fee at an assumed 1.5% of the £60,000 limit: £900.00
Cost for the year: £2,543.84

A £25,000 loan for the whole year at an assumed 9% would cost £2,250 in interest, because you pay on the full amount for all 365 days. The overdraft costs more in this example because of the fee on the limit, even though it is drawn for only 200 days. If the account were overdrawn for 120 days, the overdraft interest would fall to £986.30 and the comparison would turn the other way.

Overdraft or revolving credit facility

	Overdraft	Revolving credit facility
Where it sits	On your business current account	A separate loan account you draw into your current account
Can it be withdrawn?	Repayable on demand at any time	Committed for the term unless you breach the agreement
How you draw it	Automatically as payments clear	By notice for each drawing
Fees	Arrangement or renewal fee on the limit	Arrangement fee on the limit and a fee on undrawn money
Review	Each year	At the end of the term, and against covenants

A revolving credit facility costs more to set up and gives you certainty for its term. An overdraft is cheaper to hold and can disappear at the review. For a business that relies on its limit every month, that certainty is the reason to move.

Personal guarantees on overdrafts

Banks may ask directors to guarantee a company overdraft. A guarantee makes you personally liable for the balance if the company cannot pay, and it can stay in force after you leave the company until the bank releases it. Read what a personal guarantee means for a director before you sign one.

Who an overdraft suits

An overdraft suits a business whose account moves in and out of credit across the month or the quarter, with dips that are small next to its turnover. It is cheap to hold for that job, because you pay interest only on the days you use it.

It suits a business badly when the account has been overdrawn for months on end. Banks call that hard-core borrowing, and they treat it as a loan that has no repayment plan. If your overdraft has not been in credit for a year, it is funding something permanent: a loss, an asset or a lengthening wait for customers to pay. Move the permanent part onto a term loan, or onto invoice finance if the cause is your debtors, and keep the overdraft for the swings.

Sole traders and small partnerships borrowing £25,000 or less on an overdraft are in regulated credit, which the funding search here cannot arrange. Speak to your own bank, or look at the government’s Start Up Loans scheme if you are starting out. The funding search is for limited companies and LLPs, and for sole traders and partnerships borrowing more than £25,000.

Questions people ask

Can a bank take away a business overdraft?

Yes. Business overdrafts are repayable on demand under the bank’s terms, so the bank can reduce the limit or ask for the balance to be repaid at any time, including between reviews. Ask for the reasons in writing and for time to repay. If you applied for more and were refused by one of the nine designated banks, it must offer to pass your details, with your consent, to designated finance platforms.

How is overdraft interest worked out?

Interest is calculated on the overdrawn balance at the end of each day, at the annual rate in your agreement divided by 365, and charged to the account monthly or quarterly. On top of that there is an arrangement or renewal fee on the limit. Borrowing above the limit, or without an agreed limit, is charged at a higher rate or with a fee.

Is a business overdraft better than a loan?

It depends on how you use it. For short dips where the account returns to credit, an overdraft costs less because you pay interest only on the days you are overdrawn. For money you need for a year or more, a loan gives a fixed repayment plan the lender cannot withdraw at will. An overdraft that never returns to credit should be moved onto a loan.

Do I need a personal guarantee for a business overdraft?

Banks may ask for one, and the decision is the bank’s. A guarantee makes the director personally liable for the company’s overdraft if the company cannot pay. It may be capped at an amount, and that cap can be negotiated before you sign. Check whether the guarantee covers only the overdraft or all the company’s borrowing from that bank.

What is hard-core borrowing on an overdraft?

It is the part of an overdraft that never gets repaid: the lowest overdrawn balance the account reaches over the year. If the account is always at least £20,000 overdrawn, that £20,000 is hard-core. Banks raise it at the review and may ask you to move it onto a loan with fixed repayments, or to reduce the limit step by step.

Finance is subject to status and to the lender’s terms. A personal guarantee makes you liable for the company’s debt if it does not repay, and it can be enforced against your own assets, including your home. Nothing here is a personal recommendation.

Business overdraft

How a business overdraft works

Repayable on demand

What happens at the annual review

The bank asks for figures

It reads how the account has run

It makes an offer

You accept or refinance

What an overdraft costs

Overdraft or revolving credit facility

Personal guarantees on overdrafts

Who an overdraft suits

Questions people ask

Working capital

Revolving credit facility

Working capital finance

Invoice finance

Business loans

Business overdraft

How a business overdraft works

Repayable on demand

What happens at the annual review

The bank asks for figures

It reads how the account has run

It makes an offer

You accept or refinance

What an overdraft costs

Overdraft or revolving credit facility

Personal guarantees on overdrafts

Who an overdraft suits

Questions people ask

Working capital

Revolving credit facility

Working capital finance

Invoice finance

Business loans

Start a funding search

Cover for a personal guarantee