Business Loan vs Overdraft: Key Differences Explained

Key Takeaways 

1. An overdraft loan is flexible, while other loans are fixed
2. Choose an overdraft loan for short-term needs.
3. Choose business loans for long-term goals.
4. Overdraft facility interest rates are calculated daily.
5. Business loan can be secured or unsecure, OD usually requires collateral FD or property.

Running a business in India comes with its own set of challenges. Whether you are a well-established owner or a self-employed professional, the need for quick funds is quite common. And when the time comes, two options usually stand out: Business loans and overdraft facilities (OD). 

Both offer funds, but they work very differently.

In this blog, we will break down the key differences between business loans and overdrafts, their pros and cons, how the interest is calculated, and which one is right for your business needs.

Let’s dive in!

What is a Business Loan?

A Business loan is a type of funding offered by banks, NBFCs, and other financial institutions to help businesses meet their needs such as expansion, buying equipment, managing working capital, or covering operational expenses. These loans can be secured and unsecured and come with fixed repayment options. 

A business loan gives you a financial boost to grow and manage your business smoothly no matter if you are running a startup, small business, or an MSME. 

What Is an Overdraft Loan?

An overdraft loan, or OD facility, is a flexible credit option that is linked to your business account (current account). It allows you to withdraw more money than what is available in your current account, but up to a certain amount. 

Key Features:

• Pre-set OD limit approved by the bank
• Interest is charged only on the amount you use
• Can be secured (against FDs or property) or unsecured
• Works like a revolving credit line; funds are reusable within the limit
  

This facility is ideal when your business needs short-term working capital or you are facing temporary cash flow gaps.

How Does an OD Facility Work?

When your bank approves an OD facility, you get a credit limit (like ₹5 lakhs or ₹10 lakhs) that you can use anytime. You can withdraw money, repay, and withdraw again, just like a credit card, but for your business.

Types of OD:

• Unsecured OD Limit: Given without any collateral (usually smaller limits)
• Secured OD: Backed by fixed deposits, property, or other assets
  

It’s commonly offered as

• OD CC Limit: A cash credit + overdraft hybrid
• Business current account overdraft
  

Perfect for businesses dealing with:

• Delays in customer payments
• Monthly cash flow gaps
• Seasonal demand surges

OD Limit and Interest Rate Explained

The OD limit is not the same for everyone. It depends on

• Your business turnover
• Credit history
• Type of collateral (if any)
  

Typical Overdraft Facility Interest Rate:

• Ranges from 10% to 18% per annum
• Can be fixed or floating based on your bank
• Higher for unsecured OD and lower if backed by assets
  

Banks usually revise the OD limit and interest rate annually.

CC Limit and OD Limit: What’s the Difference?

Many entrepreneurs and business owners usually get confused between CC limit and OD limit. Here’s the difference between them:

Cash Credit (CC) Limit:

1. Secured against Inventory
2. Mainly for working capital 
3. Low Interest Rates 
4. Strict End-use monitoring 

Overdraft (OD) Limit:

1. OD can be both secured and unsecured.
2. More flexible usage 
3. Slightly Higher interest rates 
4. Less restrictive terms & policies 

Overdraft Interest Calculation: How It Differs

Understanding OD interest calculation is important for cost management. Unlike business loans, where the interest rate applies to the full amount, here, where the OD facility shines, the interest is charged only on the amount you use and only for the days it was used.

Example:

Let’s say your OD limit is ₹500,000, but you withdraw only ₹100,000 for 10 days.

You’ll pay interest just on ₹100,000 × number of days × interest rate, not on the full ₹5 lakh.

This is very different from a business loan, where interest starts from day one on the fully disbursed amount. And this overdraft interest calculation on the overdraft account method ensures that you only pay what you have used. 

What Is a Personal Overdraft Loan?

While most ODs are linked to business accounts, banks also offer personal overdraft loans to salaried individuals and self-employed people.

These are

• Linked to savings accounts
• Used for emergencies like hospital bills or home repairs
• Offered with higher interest rates compared to business overdraft loans
  

Some private banks even allow online approval for these loans.

When Should You Choose an Overdraft Over a Loan?

Loans on overdrafts offer excellent flexibility but are not suitable for all situations. Here’s when they work best:

Ideal Scenario	Choose OD Facility
Need short-term cash for daily expenses	Yes
Seasonal business with irregular income	Yes
Want to avoid fixed EMIs	Yes
Already have FDs or property to pledge	Yes (Secured OD)

ODs are like a financial cushion; they’re there when you need them and gone when you don’t.

Business Loan vs OD Facility: Key Differences

Financial Structure Differences: Let’s break it down in a simple table for better clarity:

Factor	Business Loan	Overdraft Facility
Disbursement	Lump sum upfront	As per the requirement
Interest Application	On full amount	On the utilized amount only
Repayment	Fixed EMIs	Flexible repayment
Interest Rates	8-15% typically	10-18% typically
Tenure	1-7 years usually	1-year renewable
Processing Time	7-15 days	3-7 days

Documentation And Approval Process

Documents required for the business loan application process:

• Business registration 
• 3 years’ income tax return 
• 12 months’ bank statements
• Financial statement 
• Project reports (Only if applicable) 
• Collateral Documents (If the loan is secured) 

Documents required for the overdraft loan application process:

• Current account maintenance (6-12 months)
• Turnover certificate 
• Income tax returns 
• Bank Statements 
• Security Documents (Only if needed) 
• KYC Documents 

The loan on overdraft approval process is usually faster due to simple evaluation factors.

Tax Implications And Benefits

If you are applying for a business loan, then you should understand the tax implications and benefits of the same. Here are some of the benefits:

1. Interest paid is tax-deductible
2. Depreciation benefits on assets purchased
3. Clear tax planning due to fixed costs

Overdraft Tax Considerations

1. Interest paid is a deductible business expense
2. Variable costs make tax planning complex
3. Requires proper documentation of business use

Real-Life Example: Ankur vs. Saurabh

Choose Wisely

There is no one-size-fits-all solution. Your choice between a business loan and an overdraft facility depends on your business type, cash flow pattern, and repayment ability.

• Choose a business loan for long-term, one-time investments.
• Go for an OD facility if you need flexible, short-term working capital support.
  

Talk to your bank, compare the interest rates, check your credit eligibility, and then choose wisely.

Conclusion

Choosing between a business loan and an overdraft isn’t about choosing which is better; it is about which one fits your specific needs. Business loans are more structured and cost-effective funding for long-term needs, while overdraft loan facilities provide flexibility and on-demand liquidity for working capital requirements. 

There are many businesses in India that use these two options strategically, like business loans for business growth and investments and overdraft facilities for day-to-day cash flow management. Consider your cash flow patterns and funding needs before applying for any one of these. 

Always remember that the best financial decision is an informed decision. Consult with your relationship manager and compare offers from different banks, which you can easily do with BigMudra. Compare, choose, and apply. 

FAQs

Q1. Is an overdraft a type of loan?

Yes, an overdraft is a short-term loan that lets you withdraw more than your account balance, up to a set limit.

Q2. How is overdraft interest calculated?

Interest is calculated daily on the amount used and is charged monthly. You only pay for what you use.

Q3. What is the difference between the CC and OD limits?

CC (Cash Credit) and OD (Overdraft) are both working capital loans. CC is based on inventory/receivables, while OD is usually linked to deposits or a current account.

Q4. Can I apply for an unsecured OD limit?

Yes, many banks offer unsecured OD limits, especially for professionals and MSMEs with good credit history.

Q5. Which is better, an OD or a business loan?

It depends on your needs. For the short term, OD is better. For long-term funding, a business loan is more suitable.

Q6. Is a business overdraft better than a loan?

It’s better for short-term working capital, not for large purchases or expansion.

Q7. Is it better to have a loan or an overdraft?

Depends on your use case. For EMIs and structure, choose loans. For flexibility and quick use, choose OD.