What is a business overdraft?

A business overdraft is a line of credit attached to your business bank account that lets you spend beyond your available balance, up to an agreed limit. It's the second-most popular form of small business finance, after credit cards, and can help manage short-term cash flow gaps, bridging the space between money going out and money coming in.

There are two types of business overdraft: arranged and unarranged. Understanding the difference matters, because the costs can be very different.

How does a business overdraft work?

When your bank approves a business overdraft, they set a limit that you can dip into whenever your account balance runs low. You only pay for what you use, and once money comes back into the account, the overdraft reduces automatically.

Unlike a fixed-term loan, there are no set monthly repayments and no defined end date for when the facility is paid off. That flexibility is one of its main appeals. But it’s important to understand that the bank can withdraw or reduce a business overdraft at short notice, even if you haven't done anything wrong. It's not a guaranteed line of credit, and for businesses that depend on it heavily, that distinction matters.

Types of business overdraft

Arranged overdraft

An arranged overdraft is agreed with your bank in advance, before you use it. You apply for a specific limit, the bank assesses your business's finances and either approves it or not. Interest is charged daily on the amount you've used, and the rate is agreed upfront. This is the standard option for most businesses and, used sensibly, is a cost-effective way to manage short-term cash flow fluctuations.

Unarranged overdraft

An unarranged overdraft happens when you spend beyond your account balance without a pre-agreed facility in place, or when you go over your agreed overdraft limit. Banks charge significantly higher rates for unarranged overdrafts and may also apply penalty fees. Some banks will just decline the transaction rather than let you go into an unarranged overdraft.

What are the advantages and disadvantages of a business overdraft?

The main advantage of a business overdraft is that it’s flexible, allowing you to borrow only what you need, and therefore you pay interest on what you use - not the full limit. It’s also revolving and is repaid automatically as money enters your account, meaning it’s then available to use again. A business overdraft can be useful for short-term cash flow gaps and things like timing differences between outgoings and income.

And the disadvantages? A business overdraft can be repayable on demand, and the bank can withdraw the facility at short notice. It’s intended to be used for brief periods of time, and isn’t designed for large or long-term funding needs so if you’re constantly using it, it might be that you need a different type of finance instead. 

Going into your business overdraft can be expensive, and you need a business bank account to be able to do it - both of these things may come with additional costs.

What does a business overdraft cost?

Costs vary between banks and depend on the size of the facility and your business's financial profile. Most lenders charge:

• An arrangement fee - usually a percentage of the overdraft limit, charged when the facility is set up or renewed.
  
  

• Daily interest on the balance used - expressed as an annual rate, usually somewhere in the range of 10% to 20% EAR for arranged facilities, though this varies by lender.
  
  

• Higher charges for unarranged use - significantly more expensive if you breach your agreed limit or use the overdraft without one in place.

Some banks also charge a monthly or annual facility fee regardless of whether you're using the overdraft or not. Always check whether there's a standing charge before you agree to a facility you might not use regularly.

Alternatives to a business overdraft

An overdraft isn't the only way to manage short-term cash flow. Depending on your situation, one of these alternatives might be a better fit.

A business credit card can be useful for covering smaller, ongoing costs. Most business credit cards come with an interest-free period of up to 30 to 56 days, which can be enough for short-term gaps. A business credit card can cover smaller ongoing costs without requiring a full overdraft facility.

A short-term business loan is better suited to larger, one-off funding needs where you know exactly how much you need and want predictable monthly repayments. For larger one-off funding needs, short-term business loans may be more appropriate than something that revolves like a business overdraft.

A flexible line of credit like FlexiPay is another option for businesses that want flexible access to credit. It’s particularly useful for businesses that need to pay suppliers, cover VAT bills or manage stock costs on their own schedule rather than the banks.

Find out more about how FlexiPay can benefit your business if you need an alternative to your business overdraft.

FAQs

What is the difference between a business overdraft and a business loan?

A business overdraft is a revolving facility attached to your bank account - you dip in and out as needed, and interest accrues only on what you use. A business loan is a fixed amount borrowed for a defined term, repaid in monthly instalments. In addition, the interest on variable interest rate loans can vary over time. Overdrafts work well for short-term, recurring cash flow gaps. Loans are better suited to larger, planned investments where you want certainty over repayment costs. 

Can a limited company have an overdraft?

Most UK banks offer business overdraft facilities to limited companies, subject to credit assessment. The facility is attached to the company's business bank account, and the company - rather than the individual directors - is the borrower. Some lenders may still ask directors for a personal guarantee, particularly for newer companies or those with limited trading history.

18/06/26: While we want to help as much as we can, the information found here is provided solely for informational purposes and should not be considered financial or legal advice. To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, the information contained here. If you have any questions, please speak to your professional adviser or seek independent legal advice.