Overdraft

Definition

It's the 28th of the month. Payroll is due tomorrow, but your biggest client's payment won't land until the 5th. Your current account shows Rs 8 lakh; payroll is Rs 14 lakh. Without an overdraft facility, you're calling your client begging for early payment or asking employees to wait. With one, the bank lets you overdraw up to your pre-approved limit (say Rs 25 lakh) and you pay interest only on the Rs 6 lakh shortfall, only for the 7 days it's outstanding. That flexibility is why overdrafts are the most commonly used working capital tool for Indian businesses.

Banks offer several flavours. Clean overdrafts are unsecured, purely based on your creditworthiness and banking relationship (and accordingly carry higher interest rates). OD against fixed deposits uses your FD as collateral, typically at 90% of FD value with interest rates just 1-2% above the FD rate. OD against property, against life insurance policies, and against book debts (essentially cash credit) round out the options. Interest rates sit higher than term loans but lower than credit card advances. The limit gets reviewed and renewed annually, and if your account conduct has been poor (bounced cheques, persistent high utilisation), expect a reduction.

Tax treatment is straightforward but important. Interest on business overdrafts is deductible under Section 36(1)(iii) of the Income Tax Act. However, OD interest is not eligible for GST input tax credit because banking interest is classified as an exempt supply. What does get talked about less: consistently maxing out your overdraft limit is a warning signal. Banks track utilisation patterns. If you're drawing 90%+ of your limit month after month, expect questions during credit reviews. Auditors notice it too. High overdraft utilisation relative to turnover suggests a structural cash flow problem, not a temporary timing gap.

Key Points

• An overdraft lets you withdraw beyond your balance up to a pre-set limit. You pay interest only on the overdrawn amount, only for the days used.
• Types: clean (unsecured), against FD (90% of deposit value), against property, against insurance policies, and against receivables.
• OD interest rates are higher than term loans but the pay-as-you-use model makes them cheaper for short-term, intermittent needs.
• Interest is tax-deductible under Section 36(1)(iii) of the Income Tax Act, but not eligible for GST input tax credit.
• Banks review and renew OD limits annually: poor account conduct or persistent high utilisation can trigger limit reductions.
• Consistently maxing out your OD signals structural cash flow issues to both banks and auditors.