A bank overdraft is when someone or a business is able to spend more than what is actually in their bank account. If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest is normally charged at the agreed rate. If the negative balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply.
A bank overdraft is a type of intentional short-term loan as the money is technically borrowed, the associated fees are accepted and the overdraft covered with the next deposit. Overdrafts are a source of working capital financing for many businesses.
A small business experiencing seasonal cash flow problems or late payments may use an overdraft in order to cover their everyday working capital needs like employee pay or payment to suppliers and pay the difference back when their next invoice is paid.
Invoice finance offers an alternative to business overdrafts. Invoice finance enables you to convert outstanding invoices into working capital, giving you funding at a cheaper rate than overdrafts, access to higher limits (typically 20% of revenue, as opposed to 2.5% of revenue with overdrafts) and within 24 hours.
Banks will also charge extra fees if you go over your limit and often refuse larger limits or ask for guarantees.