Question

What is overdraft ?

Hint:

Think of an overdraft as a 'financial safety net' for your bank account. It allows you to spend a little more than you have, for a short period, to cover immediate needs, but you have to pay interest on that 'borrowed' amount.

Answer 1

An overdraft (or bank overdraft) is a short-term credit facility provided by a bank that allows a current account holder to withdraw more money than is available in their account balance, up to a pre-approved limit. In effect, it is a loan from the bank that is activated when the account balance goes below zero.
Key features of an overdraft facility include:

Nature: It is a form of short-term, revolving credit. The borrower can withdraw, repay, and withdraw again up to the sanctioned limit.

Interest Calculation: Interest is charged only on the amount that is actually overdrawn and for the number of days the account remains overdrawn. This makes it a flexible and cost-effective source of short-term finance compared to a regular loan where interest is charged on the entire principal amount.

Purpose: It is primarily used to manage temporary cash flow shortages and meet working capital requirements.

Security: It can be secured (backed by an asset like property or inventory) or unsecured, depending on the bank's policy and the customer's creditworthiness.

Liability: On a company's balance sheet, a bank overdraft is shown as a current liability.