Overdraft is a sort of short-term loan established by mostly all the leading banks and NBFCs. They sometimes refer to rotating credit facilities and are considered as a part of your bank account.
An overdraft feature is to be used only when it is essential, such as buying a new stock or raising cash flow. For example, if a client has paid a high order for 30 days, you have to hit your overdraft account to purchase raw materials or shares to fulfill that order. Once the customer has paid, you can repay the loan.
If you have a running overdraft component in your account, you can make additional money from the actual account. For example, if you do not have enough money in your account or your account balance is zero, still there is a possibility for you to take money from the bank in form of an overdraft. The bank will sanction a certain amount as per your requirement (suppose Rs. 50,000) and shall have to be repaid on time as defined by the bank with added interest rate amount. Therefore, if you have Rs. 50,000 overdraft account amount, Rs.10,000 have withdrawn, the interest rate applied will be on Rs. 10,000. Interest on overdraft is calculated on the rate of exchange negotiated between the bank and the customer.
Also Know: What are the rates of interest for an overdraft facility?
Overdraft Interest Calculation
The overdraft interest rate is mainly calculated by the average daily balance method. It is calculated on the basis of the withdrawn amount. For example, if a borrower has Rs. 1 lakh in his/her bank account and withdraws Rs. 20,000 as overdraft, then the interest rate shall be charged on the withdrawn amount that is Rs. 20,000 as per the pre-defined interest rate or Annual Percentage Rate (APR).
Overdraft Account Eligibility
Overdraft Against Salary: This facility can be availed by salary account holders. The overdraft amount offered is generally three times the present salary of the applicant. Salary holders are eligible who receive each month's salary in the said bank account. The company's name should also be registered with the bank or should be on the bank's list.
Overdraft on Saving Account: Overdraft being a relatively new concept, is backed by the Government of India. The borrowers are eligible for an overdraft of Rs. 5,000 or 4 times more than the monthly minimum balance maintained in the current or savings account. The account should be operational for at least 6 months and should be linked with an Aadhar card.
Advantages of Bank Overdraft
Overdraft is regularly used to facilitate tensions on the working capital and as a consequence of unexpected expenses. They are the form of financing for businesses that enjoy working capital inconstancies.
- Funds Times Mismatch: A bank overdraft is generally beneficial for businesses with a higher operating rate of money transfer. An overdraft helps to restore the cycle of rotation of the influx and out-flux of money runway. In other words, if a week or month of sales and purchases pay a lot of money release during the time and overdraft allows managing each cash flow to be caused by a running timeframe.
- Temporary money: It also ensures that you do not have enough balance in your account, paying you out of the paid time, and avoid late payment, and avoiding forfeits.
- Flexibility: The advantage of an overdraft facility is flexibility because it allows the customer to withdraw the amount at any time (up to a limited range), despite at less than one or two days of timely repayment.
- Benefit of low-interest costs: The interest is calculated only from the amount of money withdrawn. This benefit grants a higher savings of interest cost compared to a regular loan available for a specified period. With the other banks, the interest rate needs to pay even when no money is utilized. In this case, the interest rate is debited for the amount overdrawn by the customer, and it will end instantly when the amount repaid.
As part of a short-term loan, excess business expenditure has not been involved in the calculation of the business's fiscal deficit.
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Disadvantages of Bank Overdraft
There are several advantages to getting overdraft security, but there is a pitfall. The policy in which banks set up disciplinary measures, and overdraft fees are confusing to the generator, and how the overdraft charges are imposed. This leads to higher pay and reduces the benefits of the current protection plan.
- High-interest rates: For instance, the cost of borrowing is larger than the other sources of borrowing
- Risk of reduction in limit: Overdraft reduction usually occurs when the company's financial performance indicates poor performance. Therefore, this facility can be withdrawn especially when the company required
- Chasing risk: The bank overdraft facility can sometimes stay protected against other insurance companies such as inventory or shares, life insurance policies. If the payment fails, those assets are also seized as well
- Leverage of the debtor's collection: In some cases, the bank is less meticulous in the availability of overdraft facility to a debtor's debt because quick cash withdrawal has been conducted through the overdraft facility
Overdraft is a temporary facility provided by banks to meet temporary short-term cash deficits or needs. It has been noted that such a facility is at a very high cost, managing the gap of funds, or likely used as an emergency action rather than a regular financial activity. When the work is highly dependent on overdrafts for working capital financing is a low level of operational capital management and liquidity constraint faced by the company. Only temporary work capital has been financed by Bank Overdraft. Permanent labor capital needs to finance through long-term funds.
