Choose between a loan and a bank overdraft
Compare secured and unsecured loans with overdrafts by purpose, repayment, cost and risk.
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. These lessons cover Topic 1.1 only. The 2029 syllabus has a separate document and is not mapped here. Practice is self-checked, not an official Cambridge grade; full timed-paper practice and human subject-teacher review remain outstanding.
Before you begin
- No prior accounting course is assumed. For each business form, compare who owns it, who controls decisions, who supplies finance and who bears risk.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A firm borrows $20,000 against named equipment. What makes the loan secured?
What you will learn
- Distinguish secured and unsecured borrowing
- Explain the flexibility and cost risks of an overdraft
- Match borrowing to a funding need
Loans provide agreed borrowing
A loan is borrowing that is normally arranged for an agreed amount and repaid over a stated period with interest. A secured loan is backed by specified collateral; an unsecured loan is not secured against that collateral, although the borrower remains responsible for repayment.
A longer-term loan can suit an asset or expansion with benefits over several years. Fixed repayment commitments continue even if sales fall, so assess cash flow and the total interest cost before choosing.
An overdraft can bridge short-term timing gaps
A bank overdraft allows a business to withdraw beyond the available balance up to an agreed limit. It can help manage a temporary mismatch between cash receipts and payments, such as paying suppliers before customers pay.
An overdraft may be repayable on demand and can carry a variable rate or fees. It is risky as permanent finance if a business relies on it without a plan to restore cash balances.
Pause and explain
Why is an overdraft generally more suitable for a temporary cash timing gap than as permanent finance?
Worked example
A shop expects a temporary cash gap for six weeks while waiting for invoices to be paid. It also wants to buy a machine it will use for five years. Which borrowing type could fit each need?
Show the worked solution
- The six-week gap is a short-term timing problem.
- An overdraft may bridge the gap if the bank agrees the limit and repayment plan.
- The machine is a longer-term asset, so compare a term loan whose repayment period fits its use.
Answer An agreed overdraft could bridge the temporary cash gap. A term loan may better match the machine's multi-year use, subject to affordability and lender terms.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A firm needs $6,000 for a one-month gap before a large customer pays. What information should it check before using an overdraft?
Give me a hint
Check availability, price, limit and a credible exit plan.
Compare my reasoning
- Confirm the bank has agreed an overdraft and that the limit is sufficient.
- Check the interest rate, fees and whether the facility can be reviewed or recalled.
- Check that the expected receipt is reliable and will clear the overdraft.
It should verify the agreed limit and terms, calculate interest and fees, and confirm the customer payment is likely to repay the facility. An overdraft is not guaranteed merely because the business requests one.
Look for these in your work
- Facility and limit checked
- Cost checked
- Repayment source checked
A secured loan has a lower quoted rate than an unsecured loan. Is it automatically the better choice?
Give me a hint
Include the collateral risk and total borrowing terms.
Compare my reasoning
- A lower rate can reduce interest cost.
- Security may put the specified asset at risk if the borrower defaults, subject to the agreement.
- Compare total charges, repayment schedule, flexibility and the importance of the asset.
No. The lower rate is one advantage, but the business must weigh collateral risk, total cost, repayment terms and whether losing access to the asset would disrupt operations.
Look for these in your work
- Rate considered
- Security risk considered
- Contextual comparison
A seasonal business faces cash shortages for three months each year but has stable long-term demand. Should it automatically renew an overdraft every year?
Give me a hint
Consider whether the cash gap is temporary or evidence of a structural funding need.
Compare my reasoning
- Estimate the seasonal gap and its timing.
- Compare a planned overdraft facility with longer-term finance and cash-flow changes.
- Assess cost, availability, renewal risk and whether receipts will clear the balance.
No automatic answer follows. An overdraft may suit a predictable seasonal gap if the bank terms and repayment plan are reliable. Repeated reliance could be costly or exposed to withdrawal; the business should compare alternatives and forecast cash flow.
Look for these in your work
- Seasonality analysed
- Alternatives considered
- Risks and repayment included
Common mistakes
- Calling an overdraft free because it is flexible
- Forgetting that secured borrowing exposes collateral to lender remedies under the agreement
- Matching long-term assets to repeatedly renewed short-term borrowing without considering risk
What can you explain now?
What is the main distinction between a secured and unsecured loan?
Compare with the explanation
Whether specified collateral backs the borrowing
Both are loans; the security arrangement differs.
After trying it yourself, choose your next review. This is your self-assessment.
Your review choice appears on Today. Sign in to sync it across devices.
Make it stick
What is one appropriate use and one risk of a bank overdraft?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.