The difference between an overdraft and a loan
Key points in this article
- Why it’s important to understand the difference
- Which method you use depends on what kind of business you’re running
- We’ve got online payment solutions that can help
Bank loans and overdrafts are both loans. They both involve borrowing money from the bank, but under different conditions. They can help businesses stay afloat or get ahead by providing much-needed funds – precisely when they’re needed. Think about why you need a loan in the first place. Will the funds be used to invest in your business in some way or to cover a short-term funding gap? Your small business banker can help you better understand the differences between loans and overdrafts so you can select the best option for your needs.
Though they both involve borrowing money from the bank, they’re set up differently with each serving its own purpose.
They’re both loans, but they function differently and are meant for different things.
Loans are granted for a specific time period, which can be long- or short-term. For example, you may need a short-term loan to finance a phone system upgrade that you’ll pay off in less than a year. On the other hand, you’ll probably need a longer term for paying off expensive manufacturing equipment, company cars, or property.
A bank loan is a long-term liability on a business’s balance sheet. As such, bank loans are appropriate for financing capital purchases like system upgrades, equipment, property, and company cars. They’re not intended for covering payroll or paying your bills during a slump.
Loans are for a specific time period.
Overdrafts are a form of short-term borrowing set up through your bank. They’re sometimes referred to as revolving credit facilities, and are a component of your business bank account.
An overdraft is a facility to use only when needed, such as buying new stock or increasing cash flow. They’re intended to tide a business over temporarily. For example, if a customer places a large order and will be paying in 30 days, you may need to tap into your overdraft in order to buy raw materials or stock to fulfil that order. Once the customer pays, you can pay off the debt.
When your account has an overdraft component, you can draw more money on the account than is actually available. For example, if you have $15,000 in your overdraft account but need to cover $20,000 in payroll for the month, you could withdraw the cash you have on hand along with the extra $5,000 needed for payroll – without having to meet with a loan officer and take out a business loan.
The overdraft amount, however, is a type of loan. You will need to pay it back – with interest.
When you establish an overdraft account, you will be given a maximum limit as to how much you can withdraw. However, your withdrawals do not need to be for a specific amount. You can withdraw small or large amounts, up to your limit, as needed.
Interest applies only to the balance outstanding, not the full amount. Thus, if you have a $30,000 overdraft account but only withdraw $5,000, interest will be applied to the $5,000 balance.
An overdraft is a short-term liability on a business balance sheet. As such, they’re best suited for situations where money is tight for the moment.
An overdraft, while still a loan, comes into effect only when needed and is set up as part of the bank account’s function.
- ANZ Business Overdraft – a line of credit accessible straight away to manage your cash flow requirements. Ideal for requirements under $2,000.
- ANZ Business Advantage Overdraft – a revolving line of credit, also accessible immediately. Great if you want to cover seasonal and working capital requirements above $2,000.
- ANZ Business Loans – a range of options that cover a variety of finance solutions.