Overdraft: A quick guide for Nigerian businesses
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An overdraft is a savior for most businesses, especially when experiencing negative financial flows. It is one of the most popular ways to borrow money from a bank. They are useful when you need to address any of your business’s frequent cash flow issues on a proactive basis.
Most businesses experience negative cash flow when customers overdraw a business’s current account into debit by a predetermined amount, and they need to instantly pay for administrative or supplier costs. Hence the need for an overdraft.
In this article, you will learn what an overdraft is, what you should consider before taking a bank overdraft for your business, and how to use an overdraft to scale your business.
What is an overdraft?
An overdraft is a credit line that lets a business or client make checks for more than their account balance, with a financing charge applied to the excess. It is an open credit that can be used repeatedly until the account balance reaches a pre-determined limit with a specific repayment date, usually one year.
It is cheap for businesses to borrow loans through an overdraft because they are low-interest loans. The arrangement costs are often rather low, and the interest rate is typically just a few percentage points above the bank’s base rate. Interest is only paid on the amount that is actually used.
Similarly, businesses seek an overdraft to cover an extremely short-term liquidity deficit. Working capital finance is used to fund a company’s day-to-day operating and unforeseen costs.
Most businesses struggle to decide whether to take a bank overdraft or not. Hence, the next subheading.
What should you consider before taking a bank overdraft?
It is important that you consider some things before taking a bank overdraft. Firstly, you must ensure that you can get control of your overdraft by managing it correctly. This means that you can stay updated about your current account information from time to time.
Lastly, ensure you understand the fees and charges that may be imposed on your overdraft. This will help you know how well to plan your finances such that you are not in debt for long.
How to use an overdraft to scale your small business
Here are four ways to use an overdraft to scale your small business:
Prepare Ahead of Time:
An overdraft facility may be beneficial when used appropriately. One important key to properly using this is anticipating financial and cash flow deficits. Is your company, for example, prone to seasonal cash flow shortfalls? You can plan to utilize an overdraft to help you pay salaries and other short-term company expenses. It is also a good idea to retain an overdraft as a backup alternative in case of need. Stress test your cash flow estimates to see if you’ll need to use the overdraft facility. Keep in mind that it also incurs interest.
Use it to close big deals
Small and growing businesses require every competitive advantage they can get. Every now and then, a wonderful opportunity presents itself, but enterprises are not in a position to capitalize on it. You can get an overdraft in such cases because it will be quite beneficial. Because of the hefty interest charges, several small company owners avoid overdrafts. They can, however, come in handy and allow you to take advantage of fantastic discounts like short-term discounts on large amounts of inventories. This can be considered as long as the interests do not overshoot your profit.
Use it to accomplish short-term goals
Some business owners fall in love with their overdraft privileges. As a result, people use their overdrafts for a variety of purposes. This is a terrible decision since increased interest rates compound over time and negate any benefits that an overdraft provides. You should only consider taking a bank overdraft when you have urgent and immediate bills to pay, money is tight, and you need some additional cash, but payday is still a ways off. Also, they are useful when you need to proactively handle typical cash flow issues.
Do your research
Nowadays, digital-only banks provide various services to their customers at lower rates than traditional banks. It’s the same with overdraft protection. If you want to use an overdraft facility, ensure you carry out adequate research.
While interest rates on overdrafts should not be the primary criterion for selecting an account, they must be considered. Lower costs and simpler approval processes may provide your company with an advantage when cash is running tight.
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