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 are looking for a bank that offers overdraft protection, U.S. Bank is an excellent choice. You can link one of several U.S. Bank business deposit or credit products to your primary account for your overdraft protection. Visit U.S. Bank’s website for more information.
How Business Overdraft Protection Works
When you write a check and it is presented to your bank for payment, if your account has insufficient funds and doesn’t have overdraft protection, the bank has two choices:
- Pay the check or payment and charge you an overdraft fee.
- Return the check or payment unpaid and charge you an NSF, or returned item, fee.
Returned checks can be financially damaging to your business and can also hurt your reputation.
If your account has 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 will 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 when you open an account
|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. When choosing a bank, find out which types of overdraft protection are offered before opening an account:
- 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 is 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 are 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 are 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 are 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 is 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 tabs on 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. If you require assistance, then see our guide on how to create a budget for your small business. It includes a free downloadable spreadsheet.
- 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 is linked to your checking. Not only will that cover you in the event of a small overdraft, but it will 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.
- 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 will keep your budget in line and prove valuable come tax season. Our article on how to find an accountant will walk you through the process and contains questions to ask your candidates.
- 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.
Frequently Asked Questions (FAQs)
Most banks that offer overdraft protection for consumer accounts will also offer it for business accounts. The type of overdraft protection may vary depending on the provider, but it will be available in most cases. Some providers will offer the service for free, while others will charge a small fee.
In most cases, an occasional overdraft will have little to no impact on your credit score. If your overdraft protection is tied to a line of credit, you could see a small decrease in your credit score due to a reduction of available credit. As long as the overdraft is being paid by the protection, the impact should be minimal.
The major downside to overdraft protection is fees charged to your account. If your account is already on the verge of being overdrawn, having extra fees charged for using overdraft protection could make your short-term finances even tighter. It is better to avoid overdraft protection fees if possible.
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 is 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.