Bank Overdraft

Definition of ‘Bank Overdraft’

A bank overdraft is a form of lending from a bank which allows a business to withdraw funds from its bank account in excess of the balance available. The bank overdraft is the amount by which the balance has fallen below zero.

Bank overdrafts are normally for a limited time period, and are used to allow for seasonal fluctuations in cash flow, providing a business with sufficient funds for its day to day working capital requirements.

Normally a business will establish an authorized bank overdraft facility with a bank which defines the maximum amount which can be utilised, the security (if any) to be given, and the fees and interest to be paid. The facility itself is not money owed to the bank, it only signifies the maximum bank overdraft available to the business.

For example, a business might arrange a bank overdraft facility of 50,000 with its bank to be reviewed on an annual basis. During the year the actual bank overdraft used might range from zero to £50,000, fluctuating on a daily basis. Interest will be calculated on a daily basis on the balance utilised, and charged to the bank account each month or quarter depending on the terms of the agreement.

An unauthorized bank overdraft can occur if the bank account falls below zero (becomes overdrawn) for what ever reason without prior agreement with the bank. An unauthorized overdraft should be avoided as apart from upsetting relationships with the bank, there are normally high interest charges and penalty fees to be paid.

The bank overdraft represents money owed to the bank and is therefore a liability of the business. As bank overdrafts are normally repayable on demand they are shown as a current liability on the balance sheet of the business.

For further information see the Wikipedia bank overdraft definition.

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