Bank Overdraft: Short-Term Relief With a High Price
Bank overdraft is a short-term outlet for money widely patronized by many new companies and small enterprises alike. An overdraft is a loan opportunity: the bank allows the business to owe it money even when the balance is lower than the zero or minimum mark. The bank gets to charge a higher interest rate. As a result, an overdraft is a malleable funding source, though it only comes to the fore when needed. It helps a business stand in periods when cash circulation is unusually low or faces a short-term cash flow problem. A practical example is a client not meeting their payment at the stipulated time, or the company not being able to sell its products to the target market as envisaged.
The debt incurred is a result of the overdraft. The bank automatically lends an amount that would be enough to process a particular transaction in the holder's account, and this amount is expected to be returned with some add-on. Regardless of how relieving and useful the overdraft can be, the expenses can reach beyond control if it is not taken care of at the right time.
There are two types. With an authorized overdraft, the deal has been made known beforehand between the bank and the account holder, with both parties consenting to a particular borrowing limit. The service fee varies for different banks, and expenses are charged daily, weekly or monthly, plus the agreed interest, often as high as 15-20% annual percentage rate. The charges can be costly, especially if the amount borrowed is relatively small. Account holders should be very meticulous and possibly avoid it if possible. Overdraft takes a large percentage of your profit, so it is not an encouraging funding source for small and medium businesses. An unauthorized overdraft has not been pre-agreed, and the account holder has spent beyond what they have; it results in higher charges and is costlier still.
Still, overdrafts have attractive benefits. They are good for money discrepancy: a business with just $3,000 in its account and four checks that sum up to $8,000 can use an overdraft to settle the bills, and the money is returned as receivables are paid. They shield you from the embarrassment of bouncing checks, which harm your credit standing. They allow timely installments, so you can pay suppliers in good time. They save paper and time, needing very little paperwork compared with long-term loans. And they provide relief at any time, provided the bank has not withdrawn the deal.