This article is part of a larger series on Business Banking.
Overdraft protection is a business checking service that allows your bank to transfer funds from a backup account, credit card, or a line of credit to pay for transactions in the event that your main checking account’s balance is insufficient. It protects you from overdraft fees and nonsufficient funds (NSF) 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, Bank of America is an excellent choice as it lets you link your small business checking account to up to five other backup accounts. If your checking overdraws, it’ll transfer the money from one of your backup accounts for free, so long as you haven’t exceeded the limit of free monthly savings transactions. Visit Bank of America’s website for more information.
How Business Overdraft Protection Works
Whenever you write a check or make a payment, the bank will first check if your account has enough funds to cover the transaction. If your balance is insufficient, the bank will do one of the following things:
- Pay the check or payment and charge you an overdraft fee
- Return the check or payment unpaid and charge you an NSF fee
Returned checks can be damaging to your business’s financial health and reputation. However, with overdraft protection, you can avoid such instances as the service transfers funds automatically from your linked account, line of credit, or credit card to cover any transaction against insufficient funds. Some banks offer the service for free 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 account, it’ll count toward any monthly transaction limits placed on the savings account. Most business savings offer at least six free transactions per month.
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, the bank transfers money from your savings to cover it. Transactions made with overdraft protection count against any limited free monthly savings transactions, so fees can apply. Examples of banks that offer overdraft protection through linked accounts include Capital One and Citizens Bank.
- 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. U.S. Bank offers overdraft lines of credit.
- 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 rates (APRs), and there’s usually a limit to how much you can advance. Bank of America is an example of an account that lets you use your credit card for overdraft protection.
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 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 mobile and online banking. Use these digital banking options to keep track of your account balances on the go.
- Make a budget and stick to it as best as possible: If you have a budget and stick to it, you limit the chances of an overdrawn account.
- Record all ATM withdrawals and debit transactions as soon as possible: When you keep accurate records of all business spending, you gain a clearer picture of your spending, which helps you avoid making excessive transactions.
- 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: Access to a small business line of credit gives you the working capital you need 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. In our list of the best small business lines of credit, we ranked Bluevine as the best overall because it offers competitive rates and fast funding.
- 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: When fewer people have access to your account, you lower the chances of excess spending.
Overdraft and NSF fees can quickly worsen a bad financial situation. While checks or payments are covered when these fees are charged, they cause negative balances or bounced payments, which can damage your relationship with your bank or client. Overdraft protection is the best way to protect your business against these situations.
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.