Overdraft protection is a business checking service that allows your bank to auto-transfer funds from a backup account, credit card, or a line of credit to pay for transactions if your main checking account’s balance is insufficient. It protects you from overdraft fees and non-sufficient funds (NSF) fees. In many cases, you can set it up for free when you open a business bank account.
If you’re seeking a bank that offers overdraft protection, U.S. Bank is an excellent choice. You can link one of several U.S. Bank business deposits or credit products to your primary account for your overdraft protection. For more information, visit U.S. Bank’s website.
How Business Overdraft Protection Works
When you write a check and it’s presented to your bank for payment, if your account has insufficient funds and doesn’t have overdraft protection, the bank has two options:
- Pay the check or payment and charge you an overdraft fee; or
- Return the check or payment as unpaid and charge you an NSF, or returned item fee.
Returned checks can be financially damaging to your business and may also hurt your reputation.
If your account has insufficient funds but you have overdraft protection, the bank will use it to cover the payment. Typically, this involves transferring funds from a linked backup account or a small line of credit into your primary checking. Some banks do this without charging a fee, while others may impose a small fee, usually less than $20.
Many banks don’t charge for transferring money from the backup account to the primary to cover an overdraft. However, if the backup is a business savings account, any transaction will count toward the monthly transaction limits imposed on that account. Most business savings accounts allow for at least six free transactions monthly.
Pros & Cons of Overdraft Protection
| PROS | CONS |
|---|---|
| Is easy to sign up for with business accounts and often offered free when you open an account | Adds up costs since fees can apply during transfers |
| Ensures payments and checks clear without dealing with returned transactions that can harm your business reputation | Reduces a limited number of free monthly transactions when linked to a savings account, which can be costly |
| Avoids NSF fees and overdraft fees | Promotes a false sense of security when a budgeting issue may exist |
| Prevents damage to your business or personal credit | Leads to more fees when the backup account or line of credit lacks funds to cover the overdraft |
Types of Business Overdraft Protection Plans
Three of the most commonly used overdraft protection plans for businesses are linking your account to a:
- Business savings account: If your checking account is overdrawn, funds are automatically moved from your savings to cover the deficit. However, this can lower your number of free savings transactions monthly, potentially leading to fees.
- Small line of credit: Some banks offer a small line of credit and will use it to transfer money when your checking is overdrawn. The interest rates for this option are typically similar to those of credit cards.
- Business credit card: It can be used the same way as a small line of credit, where a cash advance is taken from the credit card to address the overdraft. Note that rates for cash advances are often higher than standard credit card Annual Percentage Rates (APRs), and limits on cash advance amounts may exist.
Why Should You Use Business Overdraft Protection
Business overdraft protection offers several benefits, including:
- Quick access to financing
- Increased security in making business decisions
- The convenience of not having to apply for a separate credit line
- The option to pay interest only on the funds utilized
Who Needs Business Overdraft Protection
Many small businesses may never need business overdraft protection. However, if your bank offers it for free, it doesn’t hurt to have it as a backup. You can often set up the linked backup account when you open your primary account.
You might need overdraft protection for your business account if you:
- Are just starting with limited capital: When your business is just getting off the ground, you may have little to no cushion in your bank account to cover initial expenses.
- Operate as a micro business with limited income and expenses: If your business is still quite small, having access to overdraft protection can give you peace of mind in case your account gets overdrawn.
- Receive payments irregularly: Freelancers or contractors often get paid monthly or only after completing jobs, leading to fluctuating balances in their checking accounts. This can increase the risk of overdrafting.
- Don’t have a financial professional managing your finances: Not every small business can afford a full-time accountant. While it is possible to keep your books accurate on your own, it can be challenging to juggle several tasks, and mistakes can happen.
How Can I Apply For a Business Overdraft Protection
First, check the eligibility requirements of a provider to know how to qualify for a business overdraft. Most banks will assess your business and its financial history, including your credit report. You can apply for a business overdraft online, call the provider directly, or request a callback to speak with a representative from the financial institution.
You may need to provide information on how you plan to use and repay potential overdrafts. Generally, more details will be required for larger overdrafts.
How to Avoid Business Account Overdrafts
Below are some best practices to help you avoid overdrawing your business account.
- Utilize mobile and online banking: Almost all business banks offer robust mobile and online banking services. This is the easiest way to monitor your account balance at all times.
- Create and stick to a budget: Even if you run a micro business with limited funds, having a formal budget is essential. Sticking to a budget can significantly reduce the chances of overdrawing your account. See our guide on how to create a budget for your small business, which includes a free downloadable spreadsheet.
- Record all ATM withdrawals and debit transactions immediately: Keeping accurate records of all business spending helps you gain a clearer understanding of your financial habits, which can prevent excessive transactions.
- Build up your savings account for emergencies: To avoid overdrawing your account, build up the business savings account linked to your checking. This will not only cover small overdrafts but also prepare you for any unexpected expenses.
- Get access to a small business line of credit: Having a small business line of credit gives you the necessary working capital to cover minor and short-term expenses. This allows you to maintain your reserves since you won’t need to immediately pay these expenses from your checking account.
- Hire an accountant, if your business can afford it: As your business grows, consider hiring an accountant to manage your finances full-time. They will help keep your budget in check and be invaluable during tax season. Refer to our article on how to find an accountant for guidance in this process.
- Limit the number of people with direct access to your checking account: Reducing access to your account can minimize the chances of excessive spending.
Frequently Asked Questions (FAQs)
Yes, a business overdraft can help with unexpected cash flow issues and safeguard your business’s reputation. However, relying on it too much may cause you to neglect sticking to your budget.
Business overdrafts can be used to cover daily expenses, employee payroll, supplier payments, and inventory purchases when cash flow is low. They are beneficial for addressing short-term financial needs when immediate funding is critical.
The two common types of overdraft protection offered by banks are a line of credit and savings accounts, which cover transactions when your account is overdrawn.
A business may seek an overdraft to ensure short-term cash flow gaps, including unexpected company expenses are covered.
Some of the disadvantages of a business overdraft are that it cannot be used to pay for business machinery and company vehicles, which require long-term financing. Additionally, it can also create a false sense of security when a business may need to make a thorough budget analysis.
To minimize overdraft protection transfer fees, consider downloading your bank’s app and setting up account alerts to receive reminders on due payments and low balances. Regularly monitoring your account will help ensure that funds are transferred to your checking account before an overdraft occurs.
Bottom Line
Overdraft and NSF fees can result in a bad financial situation. While checks or payments may be covered when an overdraft fee is charged, they can mess up your checking account and cause bounced payments. If your bank offers free overdraft protection, it’s advisable to enroll in it, even if you don’t anticipate needing it.
When looking for a business checking account, choose the best small business checking provider that offers free overdraft protection, especially if you operate with limited capital, receive income irregularly, or don’t have an accountant.
