The return of the overdraft

While fewer businesses are borrowing money now that the worse of the pandemic is over, the 38% that still do are making more use of overdrafts.

Delays with supply chains, increasing input costs and rising interest rates are all putting a strain on working capital.

Overdrafts became hard to come by for small businesses in the aftermath of the financial crisis in 2008, but it seems the banks are becoming increasingly willing to make them available.

Bank of England data for Q2 2022 shows total borrowing on overdraft now stands at £9.6bn, 14.3% higher than it was in June 2021.

The benefits of an overdraft

The beauty of an overdraft is that interest is only paid when it is used. If the overdraft is only used for a few days in a month to cover timing differences, it is the cheapest form of borrowing.

That said, arrangement fees can be quite high as the bank needs to cover the cost of its capital and doesn’t have certainty of the interest income it will receive.

Overdrafts go wrong and become expensive when the account becomes permanently overdrawn. This might be because the business is trading at a loss, it has purchased a capital item for cash that it couldn’t quite afford, or because it is growing too quickly and doesn’t have the capital to support the rising level of sales. This is sometimes known as “overtrading”.

In any of these situations, it often pays to move the overdraft onto a loan and clear it by regular monthly instalments once the cause has been identified and addressed.

Overdraft alternatives

The growth of the ‘alternative finance’ scene after the financial crisis brought with it several new takes on the traditional overdraft.

New lenders realised that the banks were no longer providing overdraft facilities and stepped in to fill the gap.

Most of the alternatives are not cheap, but if managed correctly, they can meet a need and provide value.

Some operate on the principle of a flexible loan, which can be drawn down up to an agreed limit, repaid and then re-drawn as needed. The drawn down cash is paid as a lump sum into the main bank account to meet trading expenses, and is repaid when a cash surplus appears.  As such, it is not a fully fluctuating facility like a bank overdraft, instead you are taking, and paying for, blocks of cash as you need them. Interest is normally a fixed monthly rate on the drawn funds.

Providers of this type of loan include Credit4 and iWOCA.

Others make available a credit card with an agreed limit and an interest-free period of up to 56 days. As with a personal credit card, if you can clear the balance each month, the flexibility and interest-free period in these cards make them a brilliant way to manage your cash, but if you can’t…watch the costs soar.

Business credit card providers include Capital on Tap.

Retailers can take advantage of merchant cash advances. These work by allowing you to borrow against debit and credit card sales. Repayments are based on a proportion of your future card receipts so, the more you take in a day, the more you repay, and vice versa.

Again, there is a lot to like about these facilities in the right circumstances, but you have to keep in mind that you will be committing 10%-15% of your pre-merchant fees turnover to loan repayments. You need to make sure this won’t leave you short of cash for other essential overheads, including salaries.

Providers include Liberis and 365BusinessFinance.

Keeping on top of the cash

The best way of establishing the right working capital facility for your business is to have a firm grip on the cash that flows in and out.

CaFE is designed to give you complete visibility of your short and medium term cash position without the need for spreadsheets (or the backs of envelopes!).

CaFE uses your accounting software and machine learning to predict your available cash for up to 90 days in advance. If a shortage is anticipated, you will get an alert along with precise details of the item or items that are likely to cause the problem. This gives you plenty of time to chase in cash, negotiate with suppliers or talk to a lender about an overdraft or overdraft equivalent.

Your proposed lender is likely to be impressed by your level of knowledge too, increasing your chances of a quick ‘yes’.