It can be difficult to stay on top of your finances, and there might be occasions when your business needs a small cash injection to tide you over. Business loans are one option, but they’re not always suitable. If you think you might need a safety net for unexpected bills, revolving crediting facilities and overdrafts can be a better option – but what’s the difference?
In this blog, we’re going to look at business overdrafts and revolving credit in more detail, informing you of the key differences so you can decide which one could be best for your business.
What is a Revolving Credit Facility?
Revolving credit (also known as a revolving credit line) refers to a lender providing you with access to a set amount of money as and when you need it. You’ll be susceptible to a credit limit and will need to pay off what you use, as well as interest, to keep borrowing in the future. When you use money from a revolving credit facility, you will need to make minimum repayments per month which will be based on how much you borrow, but you can pay back more than the minimum amount per month if you have the money to do so.
The way revolving credit facilities work is that as long as you have some of your credit limit available, you can withdraw money as many times as you need to and pay interest relevant to how much you’ve borrowed and over the time period you have an outstanding balance.
Using a revolving credit facility is a good idea if you’re looking to build up a credit history because you’re a new business or haven’t borrowed before. It also provides a good safety net if you ever find yourself with cash flow issues. Compared to a business credit card, revolving credit facilities tend to have lower interest rates, making them more affordable for infant businesses.
What is an Overdraft?
A business overdraft is similar to a revolving credit facility, but the bank agrees to lend you money instead of a lender. There are two different types of overdrafts: authorised and unauthorised. Authorised overdrafts are where the bank agrees to give you a set credit limit and you can dip into it as and when you need to, paying it off when you are able to. You will be charged interest every day you’re in your overdraft, but you won’t be charged if you pay off what you owe early. You can only get an arranged overdraft if you have a business bank account.
On the other hand, unauthorised overdrafts are when you don’t agree to have an agreed credit limit with your bank, but you spend money that isn’t in your bank account, typically through direct debits coming out of your account with insufficient funds. When you enter an unauthorised overdraft facility, you will be penalised heavily and incur high penalty fees for being overdrawn, making it more sensible to arrange an overdraft if there is a possibility that you might need a buffer. Unauthorised bank overdrafts can also damage your credit rating.
Key Differences Between Revolving Credit Facilities and Overdrafts
Revolving credit facilities and overdrafts sound similar, but there are a few key differences you need to be aware of, including the following:
- Business overdrafts are quickly becoming harder for small businesses to obtain, making revolving credit facilities an easier option to secure
- Overdrafts can be more flexible and give you more leverage if you want to adjust your credit limit, and it’s quicker to make changes to an overdraft than a revolving credit facility
- Revolving credit is provided by a lender, whereas an overdraft is provided by a bank
- Revolving credit may require a director of your company to sign as a personal guarantor in order for you to secure the finance, whereas this isn’t necessary for an overdraft
- Overdrafts require a current account with the bank to be eligible, limiting you to one provider, but you have your choice of lenders when it comes to revolving credit
- You will need to pay a one time fee to obtain revolving credit, but opening an overdraft is free
Which is Better?
There is no definitive answer as to which option is better – it wholly depends on your business and your individual circumstances. If you have a current account with a bank and are eligible to secure an overdraft, this could be a good option for you, especially if you have direct debits which may take you overdrawn. On the other hand, if you want to try and find the best interest rates or aren’t eligible for an overdraft on your business account, a revolving credit facility could be ideal.
It’s important to keep in mind that both overdrafts and revolving credit are short term solutions and are not suitable for making large purchases. If you need credit to purchase equipment or to pay your suppliers, consider other types of financing such as a business loan or invoice finance.If you’re unsure what type of credit might be best for you, speak to us today. We are experts in alternative financing, including revolving credit facilities, and are best placed to answer any questions you might have. Simply get in touch with us to find out more.
