Nigerian businesses may sometimes experience negative cash flows. This arises from paying suppliers or administrative expenses. Overdrafts are a common form of borrowing from a bank. They allow customers to overdraw a current account into debit up to an agreed sum. If there is no agreed limit or notional limit the bank may create a new overdraft in Nigeria by approving the transfer.
WHAT IS AN OVERDRAFT
An overdraft is an extension of credit from a lending institution when an account reaches zero. An overdraft allows the individual to continue withdrawing money even if the account has no funds in it or not enough to cover the withdrawal.
Overdrafts have generally been seen as a cheap form of borrowing because:
- The interest rate is usually only a few percent above the bank’s base rate;
- Interest is only paid on the amount actually used;
- Arrangement fees are usually fairly small.
By taking an overdraft a customer may find that bank charges are levied for the operation of the account for the whole of the charging period, possibly three months, and the cost of these charges on top of the overdraft interest may make the borrowing very expensive. In addition many banks have introduced tougher policies towards customers taking unarranged overdrafts, charging interest at far higher rates.
Overdraft in Nigeria is structured in such a way that interest is charged only on the bank funds that have been used. If the negative balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply. Administrative charges are however taken upfront before the approved limit is set on you account.
You will need an overdraft in Nigeria if you are a trader, you import and distribute imported product, you are a distributor to a local or foreign producer of consumer goods. An overdraft is meant to enhance your working capital or cash flow. It is suppose to be allow you stock goods and sell within days and bring the money back into your account and use again to stock goods. Overdraft can also be used to fund payment of workers salaries pending when you will have your sales proceeds credited into your account.
Overdraft is not a credit availed to buy property, equipment or machines or “marry a new wife” it ls not to be used to fund capital expenditures. It is strictly to be used to fund daily cash flow short gaps.
BUSINESS USE OF OVERDRAFT IN NIGERIA
An overdraft is particularly suitable for the trader, whose borrowing for working capital will normally fluctuate daily within the arranged limit. Thus, where the normal turnover of a business is on a monthly basis, there is likely to be a certain time in the month when the borrowing is at its peak. Payment is then received for goods delivered or services rendered, and part or all of the borrowing is repaid. Conversely, as wages are paid, and materials purchased, week by week, so the overdraft may well increase until the next month’s accounts are collected and the account is again in credit.
With other businesses, or trades, this turnover, or `time cycle’, may be much longer – say every three, six, nine, or even twelve months. With others it may be even shorter. Some wholesale merchants may turn their stock over every week. The arable farmers, on the other hand, may have an overdraft that increases month by month in the early part of the year as he pays for seeds, fertilizers and wages. Repayment is made when his crops have been harvested and sold.
Wherever the time cycle, a healthy business should reflect this swing in the account. In-and-out borrowing from the bank, within an arranged maximum figure, has the advantages of flexibility and comparative low cost. Borrowing by means of an overdraft in Nigeria from a bank is, generally, the cheapest form of borrowing, since the rate of interest is usually lower than can be obtained elsewhere and the customer pays interest only on the money actually used in the business, as distinct from loans obtained from some other sources, where interest has to be paid on the full amount from the moment the loan is granted.
A healthy swing of the balance may show that money is going out and returning with profit. On the other hand, an overdraft which steadily rises and sticks at the`limit’ may be a danger signal.
PROVIDERS OF OVERDRAFT IN NIGERIA
ADVANTAGES OF OVERDRAFTS
Advantages for the bank
- Charging for overdrafts can be easily automated (with the limit and interest rate keyed into the computer).
- The percentage charged over base rate can be related to risk.
- A minimum rate can be set in case base rates fall very low (e.g. 3% over base rate, minimum 6%).
Advantages for the customer
- Interest is paid only on money used.
- No formal documentation needs to be completed.
- Arrangements can be made easily , e.g. by telephone
- Interest is charged only on the actual amounts borrowed from day-to-day and not on the arranged advance for the whole period
DISADVANTAGES OF OVERDRAFTS
Disadvantages for the bank
- Control of borrowing is difficult because there are no regular repayments.
- Credit scoring cannot usually be applied because there are no formal loan application.
- There are few opportunities to sell other services.
- Income may fall if interest rates go down.
- Difficulty in obtaining periodic and permanent reductions in the borrowing.
Disadvantages for the customer
- Heavy bank charges may be incurred.
- Accidental overdraft in Nigeria may be charged at very high interest rates.
- Arrangement fees are often charged (so there is a cost even if no borrowing is taken).
- Interest rates may rise adding to the cost.
- One year is the usual maximum period, though this can be extended.