Overdraft

An overdraft is a line of line of credit from which the amount needed to finance the company can be drawn on demand. It's a safety margin, but it comes at a price.

When the revenue of a business does not flow in so that it can continuously pay its expenses, then the company has liquidity problems. In order to always be able to pay expenses on time, our company needs money. This can be ensured by an overdraft. 

An overdraft is actually a line of line of credit available for short-term financing problems. From this credit limit, we always draw as much as is necessary. And when the revenue arrives in our bank account, we will pay back the used loan. This transaction is also known as top-up of the line of credit. Up to the size of the line of credit, the company can withdraw an unlimited number of funds from the current account during the contract period. This money can therefore be used continuously by the business. 

Having a line of line of credit available usually costs money. This is the commitment fee, which must be paid even if we do not use the credit line. At the same time, the bank only calculates the loan interest on the amount actually drawn. This must be paid until the loan is repaid by our company.

An overdraft can therefore be a convenient financial safety net for our business. However, if the overdraft is used almost completely by the company on a long-term basis, then it is worth examining the company's financial situation. In such a case, it is possible to look for another type of credit. For example, it might be worth taking out a working capital loan, because our business needs a much larger inventory. In the worst case, the managers of the company have to think about whether their activity actually promises a profits. 

Banks typically determine the size of the overdraft on the basis of annual sales. In general, 20 percent of the sales is the maximum amount of the frame. However, this may vary depending on 

• how regular the company's revenues are, 
• how strong the business is,
• is there collateral behind the loan?

If the business has been operating successfully for several years, there is a good chance that you can count on an overdraft. However, this method of financing is almost impossible for startups without a financial history. 

Banks usually also require a guarantee callable on first demand for overdrafts. This means that the banks expect the personal assets of the owners to be included in the repayment at any time instead of the company. This condition can be alarming if we do not believe in our company or if we know that it operates with very high risks (for example, a fast-growing startup). In such a case, we should look for another form of financing. This could be, for example, venture capital investment or crowdfunding.