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COMMERCE 1B03 Lecture Notes - Asset, Overdraft, Cash Flow Statement

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Financing using an overdraft
Overdraft financing is provided when businesses make payments from their business current
account exceeding the available cash balance. An overdraft facility enables businesses to obtain
short-term funding - although in theory the amount loaned is repayable on demand by the bank.
There are several important factors to consider when assessing the appropriateness of an
overdraft as a source of funding for SME's:
- The amount borrowed should not exceed the agreed limit ("facility"). The amount of the
facility made available is a matter for negotiation with the bank;
- Interest is charged on the amount overdrawn - at a rate that is above the Bank Base Rate. The
bank may also charge an overdraft facility fee;
- Overdrafts are generally meant to cover short-term financing requirements - they are not
generally meant to provide a permanent source of finance
- Depending on the size of the overdraft facility, the bank may require the SME to provide some
security - for example by securing the overdraft against tangible fixed assets, or against personal
guarantees provided by the directors
The amount of an overdraft at any one time will depend on the cash flows of the business, the
timing of receipts and payments, seasonal trends in the sales and so on. This can be illustrated
using the data below. In the example cash flow statement given below, the SME generates a
positive overall cash flow in a full year. However, due to the timing of sales receipts compared
with supplier payments, the business needs to fund a temporary overdraft during the year:
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