Business Loan Vs Overdraft - Business Loan Blog - Tata Capital

Business Loan vs Overdraft

Mar 07, 2017

Finance is the lifeblood of a business. Firms need cash to start a business, repay investors and to expand. Finance is also needed to meet expenses, develop new products and enter new markets. The day-to-day operations of a business need funds as well. Businesses may, therefore, need additional sources of finance. They may arrange funds either through business loans or overdrafts.

What are Business Loans?

In simple terms, business loans are long-term arrangements where the applicant receives an agreed amount upfront in return for paying the amount in installments over period of time with interest. The amount of interest and EMIs may be calculated with the help of a business loan EMI calculator.

An enterprise may need money to maintain its operations, invest in research and development, and to increase the number of branches, besides many other reasons. Business loans facilitate the expenses for these activities. The biggest advantage of a loan is that it does not have to be repaid by the business owner if the company fails, as loans are lent to the corporate entity, not to the owner. In case the business is liquidated, the amount is used to pay back the borrowed loan. Entrepreneurs often keep this aspect in mind while applying for business loans.

What is an Overdraft?

Businesses may encounter unforeseen events and unexpected expenditure. To fund such expenses, enterprises may need short-term funds at short notice. An overdraft helps to ensure that funds are immediately available, should the unexpected happen. Depending on the amount of overdraft required, firms have to provide security, such as tangible fixed assets or personal guarantees.

Businesses are given a maximum limit of withdrawal against an overdraft. If the amount withdrawn exceeds the limit, then additional fees may apply. In such cases, businesses may also have to pay higher interest rates.

Bank Loan VS Overdraft

The main difference between the bank loans and overdraft is the time frame. Loans are long-term arrangements, while overdrafts are used for short-term funding requirements. Loans allow businesses to borrow larger amounts. In overdrafts, businesses can borrow up to the overdraft limit. Taking a loan makes cash flow planning more predictable. This is because businesses know the time and the amount that they are repaying. The scenario with overdrafts is different. Banks may change the limit at any given time and many even ask for the amount to be paid back sooner than expected.

Overdrafts, too, have their advantages over loans. They are flexible, which means that businesses may change the amount they wish to borrow, within limits. Moreover, the interest paid is limited to the amount that is used and not the entire overdraft limit. Also, there is no fixed tenure for an overdraft. Businesses may close the overdraft any time they wish.

Commercial loans and overdrafts are common means of enterprise financing. They are an effective and simple method of financing growth and expansion. It is essential to identify which form of financing to use in the course of business. Using the right form is the elixir that helps enterprises grow, expand and develop.