Overdraft - GCSE Business Definition

What is an overdraft?

In GCSE Business, an overdraft is a short-term source of finance that allows a business to spend more money than it has in its bank account, up to an agreed limit. It's a form of temporary borrowing that is activated when the bank account balance falls below zero.

Overdrafts incur fees and interest charges that the customer must pay back, similar to a loan. However, overdrafts are more flexible because businesses only pay interest on the amount they use and for the time they use it. Banks usually check the business’s financial history before offering an arranged overdraft and will set a limit on how much it can borrow.

Businesses often use overdrafts to manage their cash flow, especially when they need to pay suppliers before receiving payment from customers. For instance, a shop might use its overdraft to buy new stock before it has sold its existing items. While overdrafts are useful for short-term borrowing, they can become expensive if used regularly or for long time periods.