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In two of the four months of the cash budget Thorne Co has a cash shortage with the highest cash deficit being the opening balance of $40000. This cash shortage which has occurred even though the company has a loan of $200000 is likely to be financed by an overdraft. An benefit of an overdraft is that it is a flexible source of finance since it can be used as and when required provided that the overdraft limit is not exceeded. Additionally Thorne Co will only have to pay interest on the amount of the overdraft facility used with the interest being charged at a variable rate linked to bank base rate. On the contrary interest is paid on the full $200000 of the company's bank loan whether the money is used or not. The interest rate on the overdraft is probable to be lower than that on long-term debt.
A drawback of an overdraft is that it is repayable on demand although in practice notice is given of the intention to withdraw the facility. The interest payment may as well increase since the company is exposed to the risk of an interest rates increase. Banks typically ask for some form of security such as a floating charge on the company's assets or a personal guarantee from a company's owners in order to reduce the risk associated with their lending.
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