February 26, 2024

Understanding bank overdraft

What is bank overdraft?

Bank overdraft is a type of transaction that occurs when you use more money than you have in your account. This can occur when you buy something and don’t have enough money in your account to cover the purchase price.

When your bank makes a loan payment, it does so by putting money from other customers’ accounts into their own accounts. This is called “borrowing.” The bank has already lent money in the form of loans to other people, so there’s no need to borrow more.

But when you use more than what’s in your account, it means that someone else (your customer) has used more than what was available for their own loan payments. As a result, at least one person will end up with less money in their account than they had before.

If this were only affecting one person every time it happened, it would be no big deal — but banks make millions of these transactions every day! So when millions of people start using more than what’s available for their own loans every day for months at a time, then eventually millions of people would be overdrawn on their accounts every day!

How expensive is bank overdraft?

Overdraft charges are not just high, they’re also very high compared to other interest rates. So if you have a regular overdraft, you will almost certainly pay more in overdraft fees than you would if you were paying off your overdraft using another method.

If you’re on a good deal with your bank and regularly use online banking, then the savings will come in overtime as you keep topping up your account. If not, then you might well find yourself having to pay a lot more than the minimum amount owed each month.

How bank overdraft reflects in accounting?

Bank overdraft in trial balance or balance sheet is reflected as credit. This is because the interest rate on the overdraft has to be paid back by the borrower in less than 12 months hence it is sort of a short term loan. Typically the overdraft amount along with the interest is paid off in the next payment. However, if it does exist beyond that because of non-payment then it should be reported as liability in the balance sheet. However, for the company that is taking the bank overdraft it is a liability.

Advantages of bank overdraft

One of the biggest advantages of bank overdraft is that it is ideal for paying off short-term liabilities regardless of whether there is money in the account or not. This prevents the situation wherein the payment is not executed on time thereby adding up to arrears. This is especially useful for unexpected or sudden requirements. Hence it is widely considered as the most uncomplicated option for taking a loan since you don’t need to go through a separate loan procedure in order to overdraft. The bank offers this freedom since it places high trust in the payback of loan within time hence it sort of a guaranteed post-dated cheque for the bank.

 

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