How to Manage an Overdraft

In modern business practices and in personal financing, business entities and persons alike may need additional funding than the funds that are actually available in a banking account. The requirements are often short term and funding is best paid off within a short period of time as cash flow improves. The term ‘overdraft’ is used to describe such additional funds made available by a bank against a chequing account maintained by a business entity or a person. However, similar to a loan, overdrafts should also be managed accordingly. This is because neglected and continuing overdrafts become a financial burden and substantially harm account holders’ credibility if they go unpaid.

Managing an overdraft begins from the time of negotiations between the account holder and the bank, and with regard to establishing an overdraft facility and its limits. Thus, overdraft limits should not be set arbitrarily at higher levels, but should only be based on the need, which ideally should be planned many months ahead. However, there are instances in which the overdraft facility is used purely as a safety cushion for a particular period of time. This should also be pre-planned, as unnecessary dependence on overdrafts for a prolonged period does not paint a rosy picture with regard to account holders’ financial stability.

In ideal circumstances, overdraft facility should not be used for anything other than replenishing working capital for a short period of time. Thus, for other types of investments, sources of funding that makes more economic sense should be used rather than utilizing the overdraft facility.

According financial experts, the perfect indicator to recognize a particular overdraft facility is being used healthily is to see an alternating overdraft balance and a credit balance in the account in question at least every two to three months. This ensures that the overdraft facility does not go beyond the account holders control, and that the cash flow is sufficient to manage the overdraft as expected by both the account holder as well as by the bank.

If the overdraft runs into difficulty as depicted by a prolonged overdraft that does not revert to a positive balance with the incoming cash flow, the account holder should seek the support and the expertise of the bank to rectify the issue. Being experienced in handling such issues, the bank would be in an ideal position to give advice with regard to minimizing the overdraft as well as to suggest other means of financing according to the need and the intended cash flow.

Therefore, it is apparent that an overdraft should not be considered an instrument that can be used haphazardly, but a facility that should be used to bridge the gap between expected cash flow and the expenses for a particular period of time. However, the dangers of mismanaging an overdraft should not deter an entity from harnessing the positives of such a facility to maintain ongoing businesses even in the bad times.