Overdraft protection for businesses: Pros and cons
Managing funds. Source: Unsplash
Even the most financially meticulous enterprises can fall short of funds. Especially during the current pandemic, money can be tight and hard to come by for many businesses. For instance, anticipated deposits may come in late and miss scheduled invoices. And if your balance falls below zero, you will further incur expenses, such as a non-sufficient funds (NSF) fee. Such penalties can disrupt business operations as NSF and overdraft fees come at a steep price. Last 2019, the standard overdraft fee for most banks was $35, with an average of $33.6, according to BankRate.com.
This is where overdraft protection comes in. With this, the bank allows business transactions to push through despite inadequate funds while dodging said fees. It works as a form of credit, where money is lent to cover the check, debit card, wire, and electronic transactions. While there are apparent benefits, it also has its drawbacks. Hence, here are both the pros and cons of overdraft protection for businesses.
High fees
Overdraft Protection does not come without its own cost. It serves as a source of income for banks and a preventive measure for people misusing the service. The fees can be pricey, costing at least $10 per transaction and as much as $35, which is within the same price range of NSF and overdraft fees. Some services have charged excessively, which led to bank overdraft fees lawsuits. Law firm Schmidt & Clark have listed at least six banks facing legal charges in the US alone. Involvement in a legal case can even further make a significant financial dent, especially on smaller businesses. That is why overdraft protection should not be imposed on every customer.
Encourage overspending
Knowing you have this kind of safeguard, you can potentially feel more leniency with your spending. It can disrupt your financial discipline, spending, and investing with funds that are not yet yours. And on top of this, costly fees are attached to every transaction. Hence, even minor transactions after falling below zero can add up to a hefty amount. Treating a client with a free $30 meal can double once you key in the cost of overdraft protection. That is why it is only advisable to use it in times of urgent need.
Insufficient backup source
Some setups of overdraft protection link business checking accounts to other savings accounts. They will get funds from those accounts in case of an overdraft. The fees for this setup are usually lower, making it an optimal choice for startups on a budget. However, if these accounts still hold inadequate funds, transactions will not push through. You will need a separate source of funds that is untapped in case of emergencies. In addition, linking your personal savings account has its risks. Your money will run out quickly if you use this service often to cover business financing.
Despite the high cost and some risks, why do some businesses still opt to avail the service?
Avoiding embarrassing situations
Overdraft protection comes in handy during social situations. When in front of a client, it is not ideal to reveal your business’ financial status. It may cause an unappealing image of your brand if a merchant gives back your declined card. Your card swipe will still pull through with this service.
Fill financial gaps
The primary purpose of this program is to loan money from another source until you can pay. It is particularly helpful to smaller and upcoming entrepreneurs where almost every penny is already allocated for something. For example, you have to pay the utility bills or operational costs. But suddenly, your expected payment is delayed for a few days. Overdraft protection can serve as an emergency source of funds. You do not have to worry about your store’s power being cut off or your employee’s salaries getting delayed.
Unforeseen expenses
You cannot predict every cost that will come up with your business. When on a tight budget and an urgently needed expenditure comes up, overdraft protection can cover for it in the meantime. Usual examples are major repairs for equipment or venues that require you to shell out a big sum of money. You can still run a check on your contractor while your business is operational.
Overdraft protection requires responsibility, and you should fully understand its financial repercussions. Even if you decide to use it as your business’ safety net, it will not completely resolve your future financial crises. It is still wise to have enough to pay for whatever you need and lessen the dependence on loans and credits. Monitoring your business expenses should also be a habit. Luckily, doing that is much more convenient now with the rise of technology. Banks have developed their mobile application where you can do transactions and check your balance. You must always be careful with handling your finances so as not to end up with less than what you started with.
