Business Overdrafts and Working Capital

Key takeaways

• Size the facility from your cash conversion cycle, not from a guess.
• A working capital facility should swing - drawn and repaid within the cycle.
• A permanently drawn overdraft signals a structural problem, not a timing one.
• Line fees are charged on the limit whether you draw it or not.

How do you size a working capital facility?

Start from the cash conversion cycle: the number of days between paying for inputs and collecting from customers.

Cash conversion cycle = days inventory outstanding + days sales outstanding - days payable outstanding.

A business holding stock for 40 days, collecting in 45 days and paying suppliers in 30 days has a cycle of 55 days. It is funding 55 days of operating costs before the money comes back. Multiply your daily operating cash outflow by that number and you have the approximate working capital requirement.

Add a margin for seasonality and for your largest customer paying late, and that is your facility size. Sizing this way also tells you something more useful: shortening the cycle - faster invoicing, tighter collections, better supplier terms - reduces the facility you need at all.

What are the options?

Match the facility to the shape of the gap. Financing long debtor days with an overdraft secured against your home is a much worse trade than invoice finance secured against the invoices themselves.

What does a lender look at?

Beyond the financials, lenders look at how the facility behaves.

• Does it swing? A facility drawn and repaid within each cycle is working capital. One permanently at the limit is term debt in disguise, and will be treated as such at review.
• Bank statement conduct - dishonours, ATO payments, and whether the account operates within its limit.
• Debtor concentration - one customer at 60% of revenue is a risk the lender prices.
• ATO position - outstanding tax debt is a major factor, though a documented payment plan is far better than an undisclosed liability.
• Security - most bank facilities want property or a general security agreement, and usually directors' guarantees.

Facilities are typically reviewed annually, and a review can reduce or withdraw a limit. That is the risk to plan for: do not build a business model that only works with a facility that someone else can remove at twelve months' notice.

Frequently asked questions

How big should my business overdraft be?

Size it from your cash conversion cycle - days of inventory plus days to collect, less days to pay - multiplied by daily operating cash outflow, plus a margin for seasonality and late payment. A round number chosen without that calculation is usually wrong in one direction or the other.

What does a business overdraft cost?

Interest on the drawn balance plus a line fee calculated on the approved limit, and usually an establishment fee. Because the line fee applies whether or not you draw, an oversized facility costs money for nothing.

Do I need property security for a business overdraft?

Most bank overdrafts want property security or a general security agreement over business assets, plus directors' guarantees. Unsecured facilities exist but are smaller and priced considerably higher.

What if my overdraft is always at the limit?

That indicates a structural funding gap rather than a timing one, and lenders read it that way at review. The usual answer is to restructure part of it into term debt or address the underlying cash cycle - not to request a larger limit.

Related reading

• Small Business Line of Credit: How It Works and When to Use One
• Invoice Finance vs Overdraft: Which Fixes Your Cash Flow?
• Business Loan Types: A Complete Australian Guide

Sources

• Moneysmart - business finance — ASIC
• Small business lending — Australian Banking Association