This finance is ideal to use as bridging finance in sense that it should be used to solve the company’s short term liquidity problems in particular those of financing working capital (W.C.). It is usually a secured finance unless otherwise mentioned. Overdraft finance is an expensive source of finance and the over-reliance on it is a sign of financial imprudence as it indicates the inability to plan or forecast financial needs.
- Advantages of Overdraft Finance
- It is useful in financial crisis which an accountant cannot forecast due to abrupt fall in profits thus liquidity problems.
- In some cases it may be secured on goodwill thus making it flexible finance.
- It does not entail preconditions and is therefore investible in high-risk situations when the firm would not have finance in normal circumstances.
- It is raised faster and as usual is ideal to invest in urgent ventures e.g. documentary investments e.g. treasury bonds, shares, treasury bills, housing bonds etc.
- If not used for a long period of time – it does not affect the company’s gearing level and therefore does not relate to company’s liquidation or receivership.
- Less formalities/procedures involved.
Disadvantages of Overdraft Finance
- It is expensive as the interest rates of overdrafts are much higher than bank rates.
- The use of this finance is an indication of poor financial management principle.
- It may be misused by management because it does not carry pre-conditions
- Being a short-term financial arrangement, it can be recalled at short notice leaving the company in financial crisis.
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