Overdraft Facility

What is an overdraft facility?

Overdraft facility (German: Kontokorrentkredit) refers to a short-term bank loan on the company's current business account that the company can use as needed up to an agreed maximum, repay and draw on again. The maximum is called the credit line (Kreditlinie or Kontokorrentlinie). The bank charges interest only on the amount actually used at any time, not on the whole line.

In everyday terms, this corresponds most closely to the overdraft on a private current account, but with larger amounts and its own contractual rules. In the German Mittelstand (medium-sized business sector), the overdraft facility is the standard instrument of working capital financing, that is, the financing of the ongoing business. It bridges the time between the payment of wages, suppliers and materials and the receipt of payment from customers. It is agreed in an overdraft agreement with the company's main bank (Hausbank). The agreement sets the amount and term of the line, interest, commission, collateral and termination rights; the bank's general terms and conditions apply in addition. In valuation and company sales, the amount drawn counts towards net financial debt, that is, financial liabilities from which freely available liquid funds are deducted.

How it works: line, drawdown and costs

The term Kontokorrent comes from Italian and means current account. The HGB (German Commercial Code) regulates this form of accounting in Section 355 HGB. Under it, the mutual claims arising from a business relationship are set off continuously and settled at regular intervals by determining the balance. The balance is the amount left after all credits and debits have been set off. The loan itself is a loan within the meaning of Section 488 of the German Civil Code (BGB), which is not paid out in one amount but made available as a facility.

The costs usually consist of up to three components:

• Debit interest on the amount drawn: calculated to the day on the negative balance and usually charged quarterly. It is variable: either linked to a reference rate such as EURIBOR, at which banks in the euro area lend to each other, or adjustable under contractual rules.
• Overdraft interest: a surcharge on amounts drawn beyond the agreed line (tolerated overdraft). It is often several percentage points above the debit interest.
• Commitment or credit commission: a fee for the bank keeping the line available. It is usually calculated on the unused part, in some cases on the whole line, is not charged by all banks and is negotiable.

Formula: overdraft interest = sum of the daily debit balances × debit interest rate ÷ 360 (or 365, depending on the interest method in the contract)

Beyond the line, there is no entitlement to payment. The bank can reject transfers and direct debits that exceed the facility. Returned direct debits are a warning signal for suppliers, and the account data feed continuously into the internal rating with which the bank classifies the company's creditworthiness.

Term, termination and legal framework

Overdraft lines are often committed without a fixed term (“until further notice”) or for one year with subsequent extension. For loans without an agreed term, the general terms and conditions of banks and savings banks provide an ordinary right of termination that can in principle be exercised at any time. The bank must take appropriate account of the customer's legitimate interests and generally grants a reasonable period for repayment. A committed term restricts ordinary termination and is therefore a subject of negotiation in its own right.

Irrespective of the term, the lender can terminate extraordinarily under Section 490(1) BGB. The condition is that the company's financial position or the value of collateral deteriorates significantly or threatens to do so, and repayment is thereby endangered. Contractual grounds for termination are added, such as a breach of covenants, that is, of conditions such as minimum values for financial key figures, or a change of shareholders. On termination, the amount drawn becomes due for repayment.

The real risk of the instrument therefore lies less in the interest than in the possibility of termination. Banks typically cut or terminate lines when the figures deteriorate, that is, in the phase in which the company needs the line most urgently.

Use: current assets, seasonality and maturity matching

The overdraft facility serves to finance current assets: inventories, trade receivables, pre-financed projects. Its requirement follows working capital, that is, the capital tied up in inventories and customer receivables less supplier liabilities. If revenue grows or customers' payment terms lengthen, the drawdown rises, even if the company is operating profitably.

The yardstick for proper use is maturity matching (Fristenkongruenz). Assets tied up long term and start-up losses belong in long-term financing, short-term fluctuation requirements in the line. An overdraft that regularly returns to zero over the course of the year fulfils this purpose. If a base remains permanently drawn (Bodensatz), by contrast, the line actually finances long-term needs, at a higher interest rate and with the risk of short-notice termination. In practice, this part is converted into a loan with scheduled repayment.

As collateral, banks often require for overdraft lines a global assignment (Globalzession), that is, the assignment of all customer receivables to the bank. For trading companies, the transfer of ownership of the warehouse stock as security is added: the bank becomes the owner of the goods, and the company uses and resells them. The global assignment has a side effect: the assigned receivables are no longer available for factoring or a second lender as long as the bank does not release them.

Overdraft lines for young technology companies

Banks size an overdraft line by whether the company can repay the drawdown from ongoing business. They evaluate annual financial statements, current monthly figures, the account conduct and the planning. Young technology companies with start-up losses often do not meet these criteria, even immediately after a funding round. From the bank's perspective, high liquidity from equity does not replace positive cash flow, but it improves the starting position in the loan discussion.

In practice, such companies often obtain a line initially in a small amount, against a pledge of a balance or against assignment of receivables from customers with strong payment records. Individual banks focusing on growth companies also provide lines after a funding round, usually combined with a minimum liquidity covenant. As a complement to equity, the line is worthwhile once recurring revenue with payment terms arises: it prevents equity being tied up in the stock of receivables. It does not finance start-up losses or product development. In calculating the runway, that is, the time for which the existing funds last, a line that can be terminated at any time is therefore at most to be treated as a reserve.

Worked example: calculating overdraft interest and refinancing the base

A provider of cash register systems with its own software generates EUR 7 million in revenue. It has an overdraft line of EUR 600,000 at a debit interest rate assumed to be 8% per year. The account statements of the last 12 months show an average drawdown of EUR 330,000, a lowest level of EUR 200,000 and a highest level of EUR 560,000.

• Interest costs for the year, calculated simply on the average: EUR 330,000 × 8% = EUR 26,400
• Base (Bodensatz): The drawdown was never below EUR 200,000 on any day. This amount finances permanent needs, not fluctuation.
• Free reserve in the peak month: EUR 600,000 minus EUR 560,000 = EUR 40,000, just under 7% of the line
• Refinancing: A four-year loan at an assumed 5.5% replaces the base. Interest difference EUR 200,000 × (8% minus 5.5%) = EUR 5,000 in the first year, before taking the ongoing repayment into account
• Highest drawdown after refinancing: EUR 560,000 minus EUR 200,000 = EUR 360,000; free reserve in the peak month: EUR 600,000 minus EUR 360,000 = EUR 240,000
• New burden: repayment of EUR 200,000 ÷ 4 = EUR 50,000 per year, which must come from ongoing cash flow

The interest advantage is modest; more important is that the risk shifts. Before the refinancing, a cut of the line by a tenth to EUR 540,000 would have taken the company over the facility in the peak month. Afterwards, even with this cut, a buffer of EUR 180,000 remains. If the repayment does not come from cash flow, however, the base in the overdraft grows again.

Distinction: overdraft facility, loan and supplier credit

• Loan (working capital loan): is paid out in one amount and repaid under a fixed repayment schedule; repaid amounts are not available again. It is more predictable and harder to terminate than a line, but not flexibly drawable.
• Supplier credit: a supplier's payment term. It costs no stated interest, but the cash discount (Skonto) that lapses once the discount period has expired. On an annual basis, this is often more expensive than the line, which is therefore often used to pay within the discount period.
• Dispositionskredit (consumer overdraft): the overdraft option on a private current account. It is subject to the consumer protection rules of Sections 504, 505 BGB, which play no role for the overdraft facility of a GmbH (German limited liability company).
• Guarantee facility (Avalkredit): not a cash loan but a guarantee or bond by the bank. Guarantees are often counted against the same overall line and reduce the free overdraft facility.
• Factoring: the sale of receivables to a factor. Liquidity arises from the stock of receivables itself and grows with revenue, instead of being tied to a fixed line.

Common mistakes

• Permanent drawdown. An account that never returns to zero finances long-term needs on short-term terms and with a short-notice termination risk.
• No buffer in the peak month. Anyone who exhausts the line in seasonal peaks has no reserve for late customer payments or a cut by the bank.
• Line not reflected in liquidity planning. Without weekly liquidity planning, an impending overdraft is noticed only when payments are rejected.
• Extension only shortly before expiry. Fixed-term lines are generally decided afresh each year; current figures and planning belong with the bank in good time before the extension date.

Frequently asked questions

What is the interest rate on an overdraft facility?

There is no uniform market rate: each bank builds the debit interest rate from a reference rate such as EURIBOR or its own base rate plus a margin. The margin depends on creditworthiness, collateral and the size of the line. The rate is usually above that of a loan with a fixed term, because the bank keeps the line available on call at any time.

How large should an overdraft line be?

Large enough to cover the seasonal peak requirement in working capital with a buffer. The requirement follows from revenue, customers' payment terms, inventory days and suppliers' payment terms; there is no flat rule.

Does an unused overdraft line count as liquid funds?

Not in the balance sheet. There, only balances appear as liquid funds, and a drawdown is a liability to credit institutions. For the test of illiquidity under Section 17 of the German Insolvency Code (InsO), however, committed lines that have not been exhausted are counted among the available funds. If a largely used line is terminated, this can therefore directly affect solvency.

Is the overdraft facility repaid in a company sale?

As a rule, yes. A purchase price determination on the cash-free/debt-free principle is common: financial debt is deducted from the enterprise value and free cash is added. The drawdown on the reference date counts as financial liabilities and reduces the price for the shares. Because the level fluctuates seasonally, the parties at the same time agree a target value for working capital that corresponds to the normal course of business. In this way, a randomly low or high account balance does not distort the purchase price.

The Roemer Capital view

In financial planning for clients, we evaluate the account history of the last 12 months and separate seasonal requirements from the base. The base shows which part of the line actually covers long-term needs. In the financial model, it appears as a financing building block in its own right, not as an overdraft.

Before a funding round, we agree with the company when the conversation with the main bank takes place. Shortly after the inflow of new equity, the position for a line is usually strongest. In the sale process, we prepare the course of the drawdown so that normalised working capital and financial liabilities are comprehensible in the purchase price calculation.