Why cancelling your overdraft makes perfect business sense

07/07/2019

Overdrafts have long been a popular choice for SMEs when it comes to external sources of funding, but could cancelling your overdraft put you in a better financial position?

It’s not hard to see why overdrafts have been popular in the past.

They’re often easy to set up, quick to arrange and can provide an effective way to manage short-term cash flow dips as they allow you to pay for something when you would otherwise have no money in your bank account.

But with overdrafts becoming less reliable in recent years, we look at six reasons why cancelling your overdraft makes perfect business sense.

1. It might not be around forever

Over the last ten years or so, overdraft have been less readily available to small business. Due to this many small business have began to look at other funding options that are more accessible.

According to the Small Business Finance Report from the British Business Bank, the use of overdrafts saw a continued reduction in 2018, with only 17% of small business using them.

Many SME’s have found that it may be beneficial to look for alternative options early, before the decision is potentially taken out of your hands by the bank refusing or reducing your overdraft. Particularly for smaller businesses who may rely on their overdraft to make ends meet, it may be difficult to pay it back at short notice.

2. It won’t support your long-term ambitions

When cash flow is tight, overdrafts give businesses important breathing space. But, in the longer term, relying on an overdraft for your business’s needs can be extremely unsupportive.

For instance, if you want to buy new assets without tying up cash flow or improve access to working capital, funding options exist which are specifically targeted to reaching these goals.

In contrast, the inflexible nature of overdrafts and the charges it carries can make reaching your goals more challenging.

3. It’s inflexible

Whilst having an overdraft in place can offer peace of mind to businesses who may need access to more money at short notice, if you are close to exceeding your limit an overdraft may not give you the flexibility you need.

This is particularly true in growing businesses who may find they need to quick access to working capital in order to meet increased demand.

When you need to extend your overdraft this must be agreed by the bank or you could face fines for exceeding your limit without authorisation. This process often takes time and comes with an arrangement fee, further increasing the cost of borrowing.

4. Long-term use can be expensive

Overdrafts often come with lots of charges. For example, you could be charged for arranging the overdraft, renewing the facility and increasing your limit. You will also be charged interest on the overdraft itself and could face extra fees if you exceed your limit.

As well as this, the interest rate on an overdraft is commonly variable which can make it difficult to accurately calculate borrowing costs.

It’s important to remember that costs for different funding solutions will vary greatly and the cheapest option isn’t necessarily the best. What’s more important is the value it brings to your business, so bear this in mind when deciding how to finance your business.  

5. Even accidentally dipping into your overdraft can be costly

Some businesses have an overdraft simply for emergencies when they unexpectedly need a cash flow boost. For example, when a bill comes out early, or a customer pays late.

But, even when you only dip into your overdraft occasionally or by accident, it can still be expensive.

The interest you’ll pay and any one-off charges for exceeding your limit may not seem excessive when it happens once, but when it becomes a regular occurrence the costs can quickly add up.

6. Cancelling your overdraft could lead to finding a more suitable option

Cancelling your overdraft doesn’t have to mean cancelling your funding. Part of the reason behind the drop in the amount of small business using overdrafts is that many are instead switching to other products, such as an invoice finance facility, which offer greater flexibility and customisation.

Similarly, it’s obvious that the days are gone where your bank was the only option for business finance. Now, with a large number of funding options and lenders available, businesses have more choice than ever.

As a result, it’s likely that a more suitable option for your requirements is available.

This free guide to business funding products explores some of the options available to help you get a better understanding of what will work best for your business.

Alternatively, if you’d prefer to talk through your options with one of our expert funding consultants you can contact us on 0800 9774833 or info@hiltonbaird.co.uk.