The principle of bank overdraft is very simple. Your bank authorizes you to borrow in the short term a maximum amount fixed in advance and invoices you in return for financial interest at a rate also agreed in advance.
The authorized overdraft has no minimum usage, i.e. you can call on it only when you need it – unlike a loan for which the full amount is paid into your account whether you need the full amount immediately or not.
Bank overdraft is one of the means of financing the operating cycle. Its objective is to help you overcome the cash flow mismatches linked to the company’s production cycle.
The overdraft cost is generally made up of a variable part (the base bank rate) to which is added a fixed margin proportional to the risk of the company.
The agreement authorizing the overdraft is generally put in place for a period of 1 year and then reassessed at the end of the year on the basis of the company’s financial statements. However, the bank can cancel the cancellation of the overdraft authorization at any time – with at least 60 days notice.
The overdraft facility
The operation of the overdraft facility is similar to the bank overdraft in the sense that it must have been authorized in advance by the bank and can only be used within the limit of a ceiling defined in the agreement.
The difference with the bank overdraft is that the overdraft facility is generally not usable for more than 15 days per month. That is, your account must be in credit at least half the time.
Taking into account its limit of use in the month, the overdraft facility is more suited to deal with exceptional cash lags than as a means of permanent WCR financing .
Like the authorized overdraft, the overdraft facility is generally set up for a period of 1 year and reassessed at the end of each financial year. And again the bank can cancel the authorization at any time with 60 days notice.