The short version: use an overdraft when the gap is small, frequent and unpredictable; a line of credit when you need a standing limit you draw down and repay deliberately over a longer period; and a term loan when there is a specific purchase or project with a known cost. Choosing on headline rate alone is how businesses end up paying interest on money they are not using, or renegotiating a facility every six months.
The overdraft
An overdraft is a limit attached to your everyday trading account. Your balance goes below zero when payments exceed receipts, and back above it when the receipts arrive. There is nothing to draw down and nothing to repay deliberately; it happens automatically as money moves.
You pay interest only on the amount actually overdrawn, usually calculated daily, plus a facility or line fee on the limit whether you use it or not. Facilities are typically reviewed annually and are repayable on demand, which is the feature people forget until a review goes badly.
It is the right tool for the ordinary rhythm of a trading business: wages falling before a large receipt, a quarterly BAS, a supplier who invoices on the first of the month. It is the wrong tool for funding a purchase, because there is no repayment discipline and a hardcore balance that never returns to zero will attract attention at review.
The line of credit
A line of credit is a pre-approved limit sitting alongside your trading account rather than inside it. You draw funds when you decide to, and repay on terms, with the limit available again as you repay.
Compared with an overdraft, it is usually larger, more likely to be secured, and more likely to come from a non-bank lender. The deliberate drawdown is the practical difference: money moves because you decided it should, which makes it easier to track what the facility was actually used for.
It suits recurring but lumpy needs: a business that buys stock in large quarterly runs, a contractor funding mobilisation costs at the start of each project, a business making several acquisitions of equipment over a year and not wanting a separate application each time.
The term loan
A term loan is a lump sum advanced once and repaid over a fixed period in regular instalments. The amount, term and repayment are known at the outset, and once repaid the facility is finished.
It suits a defined purpose with a defined cost: a fit-out, an acquisition, a one-off project, consolidating several expensive short facilities into one cheaper structured one. It does not suit ongoing working capital, because you pay interest on the whole balance from day one whether the money is needed yet or not.
Term loans come secured and unsecured. Unsecured is faster and requires no property, and costs more in exchange. Business overdraft vs unsecured business loan compares the two most commonly confused options in more detail.
The cheat sheet
Small, frequent, unpredictable gaps in day-to-day trading: overdraft.
A standing limit for lumpy, recurring but deliberate needs: line of credit.
One specific purchase or project with a known cost: term loan.
A gap caused specifically by customers paying slowly: none of the three. That is invoice finance, and funding it with general-purpose debt is more expensive and less flexible.
A gap caused by buying equipment: none of the three. That is asset finance, secured against the asset itself at a lower cost.
The questions that actually decide it
Is the need one-off or recurring? One-off points to a term loan; recurring points to a revolving facility. Is it predictable or unpredictable? Predictable can be scheduled; unpredictable needs to be always available. Is there an underlying asset or receivable? If there is, asset finance or invoice finance will almost always be cheaper than a general facility.
Then there is the question of what happens when the facility is reviewed. Revolving facilities are reviewed and can be reduced or withdrawn; a term loan cannot be, as long as you meet the terms. For a business that cannot tolerate its funding disappearing at review, that certainty is worth something even at a higher cost.
A common and expensive mistake
Using an overdraft as permanent capital. If the balance has not returned to zero in two years, the overdraft is not funding timing gaps, it is funding the business, and it is doing so on a facility repayable on demand. Refinancing that into an appropriately structured term facility usually costs less and removes the review risk. Working out which shape you actually need starts with a forecast, and cash flow forecasting for small business covers how to build one in an hour a week.
Where to from here
We compare working capital facilities across our whole lender panel and size them against your actual cash cycle rather than a round number. There are no fees to clients; the lender pays us when the finance settles. Book a 20-minute brief.
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