This article is part of a larger series on Business Banking.
Overdraft protection for business checking accounts allows the bank to transfer funds from a backup account, or a line of credit to your primary account, to avoid overdraft fees. In many cases, you have the option to set it up for free when you open a business bank account.
If you’re looking for a bank that offers overdraft protection, Chase is an excellent choice as it lets you link your business checking account to your business savings. If your checking overdraws, it’ll transfer the money from your savings for free as long as you haven’t exceeded the limit of free monthly savings transactions. Visit Chase’s website for more information.
How Business Overdraft Protection Works
When a check or an electronic payment is presented to your checking account, the bank will see if you have sufficient funds for it to clear. If there are insufficient funds and you have overdraft protection, the bank will use it to cover the payment.
To pay, the bank transfers funds from either your linked backup account or a small line of credit into your primary checking. Some banks do this at no charge while others charge a small fee, usually less than $20.
Many banks won’t charge for transferring money from the backup account to the primary to cover an overdraft. However, if the backup account is a business savings, it’ll count toward any monthly transaction limits placed on the savings account. Most business savings offer at least six free transactions per month.
If your account has insufficient funds and doesn’t have overdraft protection, the bank has two choices: it can pay the check or payment and charge you an overdraft fee or return the check or payment unpaid and charge you a nonsufficient funds fee (NSF). Returned checks can be financially damaging to your business and can also hurt your reputation.
Pros & Cons of Overdraft Protection
|Is easy to sign up for with business accounts, often offered for no charge||Can have fees when transfers take place|
|Ensures your payments and checks clear without dealing with returned transactions, which can damage your business reputation||Counts against a limited number of free monthly transactions, if linked to a savings account, which can get expensive|
|Avoids NSF fees and overdraft fees||Can give a false sense of security when there may be a larger budgeting problem|
|Avoids damaging your business or personal credit||Can still get charged fees if your backup account or line of credit doesn’t have enough funds to cover the overdraft|
Types of Business Overdraft Protection Plans
Here are the three most commonly used overdraft protection plans for business accounts.
- Linked to a business savings account: If your checking is overdrawn, money is transferred from your savings to cover it. This counts against any limited free monthly savings transactions, so fees can apply.
- Linked to a small line of credit: Some banks offer a small line of credit and will transfer money from that when your checking is overdrawn. This account type typically has rates similar to a credit card.
- Linked to a business credit card: This is used the same way as the small line of credit, with a cash advance pulled from the credit card to cover the overdraft. Note that rates on cash advances are often higher than typical credit card annual percentage rate (APR) rates, and there’s usually a limit to how much you can advance.
Who Needs Business Overdraft Protection
Many small businesses will never find themselves in a position to need business overdraft protection. Nevertheless, if your bank offers it free of charge, it doesn’t hurt to have it as a backup. You can often set up the linked backup account when you open your account.
Here are some examples of businesses that might need overdraft protection:
- If you’re just starting and have a low amount of capital: When just getting off the ground, you might not have a cushion in your bank account to cover initial expenses.
- If you’re a very small business with limited income and expenses: When your business is still very small, you might never have a large balance in your account. Overdraft protection gives you peace of mind for when something happens and your account is overdrawn.
- If you get paid irregularly: If you’re a freelancer or contractor, you often get paid monthly or when jobs are completed. This can cause widely fluctuating balances in your checking account, putting it at risk of being overdrawn.
- If you get paid quarterly, semiannually, or annually: Farmers, for example, usually don’t get paid until crops are harvested. This makes things run tight financially until a large check arrives.
- If you don’t have a financial professional keeping track of finances: Not every small business can afford to have a full-time accountant on hand. While there’s no guarantee that you can’t keep your books accurate yourself, you also have many other things to worry about, so mistakes can happen.
How To Avoid Business Account Overdrafts
Here are a few best practices to avoid business account overdrafts.
- Use mobile and online banking to keep an eye on your accounts: Almost every business bank offers outstanding mobile and online banking, and it’s the easiest way to keep track of your account at all times.
- Make a budget and stick to it as best as possible: Very small businesses with limited income and expenses often think they don’t need a formal budget as they have so little money going in and out of their accounts. If you have a budget and stick to it, regardless of how big your business is, you limit the chances of an overdrawn account.
- Record all ATM withdrawals and debit transactions as soon as possible: Just like with personal bank accounts, this is one area where a business bank account working with a small average balance can get in trouble. When expenses happen and aren’t documented, you open yourself up to an overdrawn account.
- Build up your savings account for emergencies: The best way to avoid having an overdrawn account is to build up the savings account that’s linked to your checking. Not only will that cover you in the event of a small overdraft, but it’ll prepare you for any emergency expenses that might come up.
- Get access to a small business line of credit: If you have access to a line of credit, it’ll give you the working capital necessary to cover small and short-term expenses. This means you won’t have to pay for them immediately out of your checking account, which gives you a chance to build up your reserves. Bluevine is an excellent choice for a small business line of credit.
- Hire an accountant, if your business can afford it: Once your business grows to the point that you can afford to bring in someone to handle your finances full-time, you should hire an accountant. They’ll keep your budget in line and prove valuable come tax season.
- Limit the number of people with direct access to your checking: The fewer the people with access to your account, the lower the chance an expense falls through the cracks.
Overdraft and NSF fees can quickly worsen a bad financial situation. While checks or payments are covered when an overdraft fee is charged, they can mess up your checking account and cause bounced payments. If you have a business bank that offers overdraft protection for free, it’s a good idea to sign up for it even if you never use it.
When you consider your options for a business checking account, finding the best small business checking provider that offers free overdraft protection might be necessary. This is especially true if you operate with low capital, receive income irregularly, or get paid just a few times a year.