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A business overdraft happens when your business account balance doesn’t have enough in it to cover a transaction, payment, or check. In this situation, your financial institution may cover the gap for you — up to the amount it determines — making it an overdraft. In this article, we’ll look at how business overdrafts occur and what you can do to prevent them.
Key Points
• An overdraft occurs when a business account balance falls below zero and the withdrawal is allowed at the discretion of the bank — with interest charged on the overdrawn amount.
• A returned item fee may be charged by a vendor when a payment bounces due to insufficient funds, such as a rejected ACH payment or returned check.
• Business overdraft protection automatically transfers funds from a linked account — such as a savings account or a line of credit — into an overdrawn checking account when needed.
• Regularly monitoring account balances and cash flow is the most effective way to avoid overdrafts.
How Business Overdrafts Work
When a business account drops below zero, the overdraft allows the business to continue making withdrawals (up to a limit set by the bank). The overdraft amount is then charged to the business account with interest. Once the business account returns to a positive balance, the business will stop incurring interest on the overdraft. Additional fees may apply as well, depending on the lender.
When Overdrafts Occur
When a business account is overdrawn, it means the available balance is less than the amount that’s needed to cover a transaction, payment, or check. If your business doesn’t have overdraft coverage or protection, the bank will typically decline the transaction and may charge a non-sufficient funds (NSF) fee or a returned item fee.
Business Overdraft Fees Explained
There are several common business overdraft fees that a bank may charge. These include overdraft fees, non-sufficient funds fees, and returned item fees. These fees can vary by bank and account type.
Overdraft fees are fees charged by the bank covering the overdraft amount. The business will need to pay back the overcharged amount plus the overdraft fee.
Non-sufficient funds fees are charged by the business’s financial institution when it declines a transaction because the business account doesn’t have enough money in its account to cover the transaction. In this case, the bank doesn’t pay the cost of the transaction and the business is charged the NSF fee.
A returned item fee is charged by the vendor when a payment is returned due to insufficient funds. This can happen after a bounced check, rejected ACH payment, or returned payment from a vendor or customer.
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What Is Business Overdraft Protection?
Business overdraft protection helps protect your business checking account from needing an overdraft. To provide this protection, other accounts are linked to your business checking account.
How Overdraft Protection Is Set Up
With overdraft protection, if your checking account balance is insufficient, funds will be automatically transferred from the linked account into the insufficient checking account. This is meant to cover the transaction amounts and help you avoid overdraft fees and non-sufficient funds fees.
Linked Account Options
You can link your business checking account to a variety of other accounts. These can include savings, credit cards, lines of credit, money market accounts, or secondary checking accounts.
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Types of Business Overdraft Coverage
There are several types of business overdraft coverage: linked deposit accounts, business line of credit, and business credit card.
Linked Deposit Accounts
You can link other business savings accounts, secondary business checking accounts, or money market accounts to cover insufficient funds in the event of an overdraft.
Business Line of Credit
Some financial institutions offer businesses a small business line of credit to cover the overdraft amount from the business’s checking account. The interest rates for a business line of credit are typically similar to those of credit cards.
Bear in mind that a line of credit operates differently from a business loan, so be sure you understand the difference between a business loan vs. line of credit.
Business Credit Card
A business credit card can potentially be used in the same way as a small line of credit: A cash advance is taken from the credit card to cover the overdraft. Remember that the rates for cash advances are often higher than the standard credit card Annual Percentage Rate (APR) and there may be limits on cash advance amounts from a business credit card.
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Business Overdraft Protection vs Standard Overdraft Coverage
Business overdraft protection allows you to link your accounts so that funds can be transferred to your business checking account in case a check, debit card, or ATM transaction exceeds the available balance in your account.
Standard overdraft coverage is how transactions will be handled if you don’t have business overdraft protection when your available balance falls below zero. At its discretion, your bank may authorize and pay overdrafts for these transactions, but this service often comes with a fee.
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How to Avoid Business Overdrafts
The best way to avoid business overdrafts is to monitor your business’s account balances and cash flow. Be sure to check your account balances regularly and move funds around in anticipation of upcoming expenses if necessary.
If you need extra money to cover cash flow gaps, another option is to explore small business loans. There are many options, including working capital loans, or cash flow loans.
If you need cash quickly, you can also check out emergency business loans.
The Takeaway
Businesses generally don’t want to withdraw more money than they have in their account, but overdrafts can happen. With foresight and planning, however, many can be avoided. It can be a good idea to learn what your financial institution’s policies are and what protections you may be able to access before the situation arises.
Ready to grow your business? SoFi Small Business Loans can give you fast access to the capital you need. Check your eligibility in minutes.
FAQ
What happens when a business account is overdrawn?
When a business account is overdrawn, it means the available balance is less than the amount needed to cover a transaction, payment, or check. If your business doesn’t have overdraft coverage or protection, the bank may decline the transaction and may charge a non-sufficient funds (NSF) fee or a returned item fee.
How much does business overdraft protection cost?
The cost of business overdraft protection can vary by bank and account type. Banks may charge a fee per overdraft item, which can range from about $10 to $36 per item, though some banks have eliminated many of these fees.
Can a business line of credit be used for overdraft protection?
Yes, a business line of credit can be used for overdraft protection if you link it to your business checking account.
Is business overdraft protection worth it?
Business overdraft protection can definitely be worth it. It can save you from having to pay extra fees in the event of an overdraft.
How is business overdraft different from a personal overdraft?
A business overdraft may cover more than a personal overdraft and be linked to business accounts. It might help companies cover operational costs such as payroll, supplier payments, or seasonal cash flow fluctuations. A personal overdraft could be linked to individual accounts and might provide access to funds for unexpected personal expenses like medical bills.
Photo credit: iStock/ROGER YEBUAH
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