How do bank loans differ from overdrafts as financing options?

Bank loans are long-term financing options with fixed repayment schedules, while overdrafts are short-term, flexible borrowing facilities.

A bank loan is a type of debt that a bank provides to a borrower, which is typically a business or an individual. The borrower is obligated to pay back the loan over a specified period of time, along with interest. The interest rate, repayment schedule, and other terms are usually fixed at the outset. Bank loans can be used for a variety of purposes, such as purchasing equipment, expanding operations, or financing other long-term investments. They are often secured against assets, meaning that the bank can seize these assets if the borrower fails to repay the loan.

On the other hand, an overdraft is a facility that allows a bank account holder to withdraw more money than they have in their account, up to a certain limit. This limit is agreed upon between the bank and the account holder. Overdrafts are typically used to cover short-term cash flow shortages. They are more flexible than bank loans, as the borrower only pays interest on the amount they have overdrawn, and can repay the overdraft at any time without penalty. However, the interest rates on overdrafts are usually higher than those on bank loans.

In terms of risk, bank loans are generally considered less risky for the borrower, as they have a fixed interest rate and repayment schedule. This allows the borrower to plan their finances more effectively. However, if the borrower fails to meet their repayment obligations, they risk losing their assets. Overdrafts, while more flexible, can be riskier due to their higher interest rates and the fact that the bank can withdraw the facility at any time.

In summary, bank loans and overdrafts are both useful financing options, but they serve different purposes and come with different risks and benefits. Bank loans are better suited for long-term investments, while overdrafts are more appropriate for managing short-term cash flow issues.