Financial Accounting Concepts

Bank Overdraft as a Source of Finance

Bank overdraft is a common source of finance used by businesses, individuals and even governments to meet their short-term cash flow needs.

An overdraft is essentially an agreement between a bank and its customer, which allows the customer to withdraw funds exceeding their account balance up to a pre-agreed limit.

Advantages of Bank Overdraft

Quick Access to Cash: Bank overdrafts are a quick and easy source of finance. Once the overdraft is approved, the customer can withdraw funds immediately without going through a lengthy application process. This can be particularly useful in emergencies when cash is needed urgently.

Flexibility: Bank overdrafts are a flexible source of finance. The customer can draw on the overdraft as and when required and can repay the overdraft at any time without incurring a penalty. This makes it a useful source of finance for businesses with fluctuating cash flows.

Builds Credit History: Consistently using and repaying a bank overdraft can help build a good credit history, which can be useful when applying for other forms of financing.

Disadvantages of Bank Overdraft

High-Interest Rates: While bank overdrafts generally have lower interest rates than other forms of short-term finance, they can still be expensive. Interest rates on overdrafts are typically higher than on loans, so it’s important to ensure that the overdraft is repaid as quickly as possible to avoid accruing too much interest.

Limited Availability: Bank overdrafts are usually only available to businesses and individuals with a good credit history. If the customer has a poor credit score, or has a history of late payments, their application for an overdraft may be rejected.

Risk of Default: If the customer is unable to repay the overdraft, they may incur penalty fees and damage their credit score. In severe cases, the bank may take legal action to recover the funds, which can be costly and time-consuming for both parties.

Uncertainty: Unlike other forms of finance, such as loans, bank overdrafts do not have a fixed repayment schedule. The customer can repay the overdraft any time, making it difficult to budget and plan for the future.


In conclusion, bank overdrafts can be a useful source of short-term finance for businesses and individuals. They offer quick and easy access to cash, flexibility, lower interest rates, and the opportunity to build a good credit history. However, they also have disadvantages, such as high-interest rates, limited availability, the risk of default, and uncertainty. It is important to carefully consider the advantages and disadvantages before using a bank overdraft as a source of finance and to ensure that it is repaid as quickly as possible to avoid accruing too much interest.

Show More

Leave a Reply