Refers to capital borrowed from the bank. This tends to be more expensive than an overdraft. The difference between a bank loan and a bank overdraft is that a loan is granted for a specific period (say, two years), usually at a set rate of interest (that is, it doesn’t vary when bank base rates vary). A bank loan is shown on the balance sheet as a long-term liability.
Interest on the loan is recorded as an expense on the Profit and Loss Account. Any capital repayments will reduce the long-term liability on the balance sheet. Short term borrowing to help fund a temporary shortage of funds is more likely to involve a bank overdraft.
For the business, a bank overdraft is essentially short term borrowing, intended to tide the business over temporarily. Very often, the overdraft is not for a specific amount of money, but the business is given a maximum level of cash it may draw against the overdraft. A business should arrange overdraft facilities to ensure that the bank will honor cheques even though there are insufficient funds in the account to cover the value of cheques drawn.
The overdraft is repayable on demand, although it is usual to agree with the bank the period for which the overdraft is required. It has the advantage that interest accrues from day to day only on the balance outstanding and it follows the flat rate of interest. A bank overdraft is shown on the balance sheet as a short-term liability.
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