What is Overdraft Protection? Understand Why Your Business Needs It

What is Overdraft Protection? Understand Why Your Business Needs It

Last week you wrote a check for your monthly office supplies delivery. Unfortunately, between then and now, you’ve forgotten about that check — it just cleared and caused your account to overdraft. What’s even more unfortunate? You don’t have overdraft protection and were just hit with a hefty overdraft fee. This frustrating situation causes you to wonder whether overdraft protection is something you should look into.

Overdraft protection is a line of credit that banks offer to businesses to cover overdrafts. Overdraft protection kicks in when the business writes a check or completes a transaction for more than the amount in their account. It links your eligible checking account to the bank’s line of credit in order to cover the amount overdrafted. This line of credit will kick in for each transaction as necessary, often accompanied with an average fee of $35 per use.

Current Overdraft Protection Policy

In 2010, policymakers forced banks to make overdraft protection an opt-in service, prohibiting them from automatically enrolling customers in programs that charge hefty fees whenever there are insufficient funds to cover transactions. Having overdraft protection allows your business to continue to use your bank account for purchases (including ATM withdrawals) even after it is overdrawn. It’s also important to note that overdraft protection only covers debit card transactions and ATM withdrawal, not checks or other automatic debits from your account.

Benefits of Overdraft Protection

Overdraft protection is a tricky topic in business banking, but it does have some benefits. Before you opt-in to overdraft protection at your bank, you should understand why your business would need it and whether it’s the right decision for your financial strategy.

  1. If your business is in a position where your card could potentially get declined, you may want to consider opting for overdraft protection. Having your business card declined could be an embarrassing situation in front of clients, vendors or suppliers.
  2. Choosing to use overdraft protection could protect your business between paychecks — although at a price. Maybe money is tight for you between invoices getting paid. This temporary access to cash can be helpful during a financial gap or if an unexpected expense comes up.
  3. You may also consider opting in if you’d like to have cash available for emergencies. It’s more common for businesses to use overdrafting to pay bills for essentials or emergencies, such as product loss or new software upgrades.

Controversy and High Fees

However, there is some controversy around all three of these strategies. Some businesses see overdraft protection as a way to borrow money when they’re short on cash instead of going through standard credit rules and regulations (e.g., applying for a line of credit and making payments on said credit card).

Overdraft protection service can also encourage overspending. Even though it’s convenient, it can take away from the responsibility of monitoring your finances to understand what funds are available in your accounts — and whether or not you can actually afford these transactions.

If you decide to opt-in to overdraft protection, know that these fees can add up…and they’ll do so quickly if you haven’t realized your account is overdrawn. Did you take a client out to lunch? That $20 sandwich and salad could turn into $60. Or did you buy a round of coffee for the staff? That $15 latte run just cost you $50.

Overdraft Protection Alternatives

Some banks, such as Wells Fargo, announced they would no longer charge overdraft fees on transactions of $5 or less. Other banks have a daily limit on how much they will charge you for overdrafts. While this is a step in the right direction, there are alternatives to overdraft protection that could be more beneficial for your business.

If you don’t anticipate your business to need overdraft protection frequently, linking your checking account to a credit card, savings account or line of credit are also options. If your business overdraws an account, it would pull from one of these sources instead of borrowing from the bank to cover the shortfall. In this case, charges are smaller — averaging $10 instead of $35.

Account Management Tips

First and foremost, stay on top of managing your business’ finances to avoid overdrafting your account. Monitor your accounts before you pay vendors and suppliers and before you expect any automatic payments to occur. Keep a running list of monthly, quarterly or yearly payments and when they are due to avoid any surprise transactions.

Many (if not all) banks allow you easy access to online and mobile banking, which is most commonly used to check your balances and any funds coming in and out of your accounts. These platforms give you the opportunity to set alerts that notify you when your account falls below a predetermined amount. For example, you can set an alert to notify you when your account drops below $500. Even if you choose to opt-in to overdraft protection for your business, you can still set these alerts to help avoid those hefty fees, only using the service when you don’t have another option.

Overdraft protection is optional and not for every business. If you feel tempted to use overdraft protection but are wary of the fees, ask your bank to turn it off on the checking account you use most. Turning off overdraft protection could save you money over the year while motivating you to stay in tune with your business finances.

Have you been charged overdraft fees? Tell us your story or opinion on the subject on Twitter @Revenued_com.

Chris Keller is a veteran in business finance. Prior to starting and managing his own business, he managed product lines at two Fortune 500 companies focusing on their Profit & Loss statements.
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