Small business cash flow can be tight, which can lead to the threat of overdraft fees in those long weeks between getting invoiced by your vendors and clients paying your invoices. When the timing doesn't work out, you're hit with an overdraft fee that tightens your margins even further.
This annoyance can add an average of $33.36 to your expenses, cutting your profits in a way you'll have to explain to your business partner or other stakeholders. It also often creates a cascade of other fees that drops your bank balance far enough to put your company's balance sheet in a precarious state.
Sometimes, you can get these fees waived if you call the bank and plead your case. But most of the time, they'll tell you to keep your bank balance high enough to cover charges. That's all well and good when your business is flush. But if you have a new business or things are tight, it may seem easier said than done.
Thankfully, knowledge is power. Here are five reasons businesses pay overdraft fees and ways you can avoid these all-too-common mistakes.
1. Lack of backup
Lack of backup means operating without an automatic solution when your balance is too low to pay all the debits coming from the account. This is one of the simplest banking problems and has a list of easy solutions. But small business owners are often overwhelmed with other tasks and don't set up the fixes.
If you don't have solutions in place for a cash flow deficit, it becomes a cascading and self-reinforcing problem. One overdraft fee might be manageable. But if you haven't fixed the situation that led to the overdraft, you'll end up with potentially dozens of overdraft fees because the problem will reoccur.
There are many effective ways to create a backup that you can complete in a couple of hours:
- Make all company purchases on a credit card with a grace period, then pay it off when you have the balance. (This also works well because of miles and other potential rewards)
- "Cook" your internal books so you show a balance $500 to $1,000 lower than you actually have when calculating what you can afford to pay.
- Set up an automatic backup account for debits when your main account has an insufficient balance.
- Set up automated alerts for when your balance becomes low.
- You can also talk with your bank about a business line of credit, overdraft protection, or one of several other products designed to give you the backup you need.
2. The weekend timing issue
Banks process weekend transactions on Monday, and not always in the order that best benefits your business. If you make a deposit and write a check on the weekend, relying on that deposit to keep your bank balance high enough, there could still be an overdraft fee.
For example, imagine you start with a balance of $500, make a $2,000 deposit, and write a check to your supplier for $1,100. If the bank processes them in that order, your balance is $500, then $2,500, then $1,400. But if the bank processes your check first, the balance is $500, then -$600. When your deposit hits, it goes up to $1,400 minus whatever the bank charges for the overdraft.
Many business bank accounts have specific policies that avoid this issue altogether. Rather than processing weekend transactions in a way that makes you vulnerable, they work out the total balance for the weekend before assessing overdraft fees. Ask about this specifically and move your banking to an institution with this policy if you have that option.
If you don't have that option, your best bet is to simply avoid paying bills on the weekend. You need some time off anyway.
3. The payment lag
This mistake is common among private individuals and small businesses but can be more problematic for a business for two reasons. First, the amounts involved are often much larger, meaning the trouble it causes can be bigger. Second, businesses have more people involved in their finances, so it’s easier for something to go unnoticed before a problem occurs.
The payment lag works like this:
- Somebody sends out a check to pay a vendor.
- The vendor takes longer than usual to deposit the check, for any number of reasons.
- Somebody (usually somebody other than the person who sent the first check) checks the company bank balance before sending out a check to another vendor, unaware that the first check is still out there.
- Both checks get cashed, crashing the company bank balance into negative numbers.
Avoid this problem forever by establishing a bookkeeping policy where any check that goes out is recorded and deducted from your bookkeeping software when it goes out, rather than when it gets cashed. That way, when you check to see if there's money to send out a second check, you are automatically reminded of the first check.
For this to work properly, it must be accompanied by two other policies. First, any check or other payment is reported in your bookkeeping system as soon as possible. Second, any decision-maker checking to see if there’s enough money in the business accounts can verify that information in the bookkeeping system.
4. Automatic payments
This problem works a lot like the payment lag problem:
- Somebody wants to send a check to a vendor and checks the company bank balance to make sure there’s enough money.
- Finding the balance sufficient, they send out the check.
- The next day, automated payments to utilities, rent, a professional membership, and another check come out of the account, reducing the balance to below the amount needed for the first check.
- The first check gets cashed, resulting in an account overdraft.
Automatic payments are convenient, ensure good relationships with vendors, and often come with a small but meaningful discount on costs. Unfortunately, that discount is rarely comparable to the costs of overdraft fees.
This issue is similar to the payment lag problem and likewise has a similar solution. Set up your bookkeeping software to include a forecast of upcoming automatic payments, along with a running balance accommodating for those debits.
Once that's in place, check the forecast when confirming whether or not the account has funds sufficient to write a check.
5. Hidden fees
In good times, you don't need to worry about these hidden fees because your company account balances will always be high enough to handle them. However, they can make the leanest times that much leaner, hurting your bank account and your bottom line when you need both to function as smoothly and cheaply as possible.
A small, unexpected fee like an overdraft charge, a surcharge added to a negotiated price, an annual service fee, or even an ATM out-of-network fee can reduce your account balance just enough that a large payment is slightly higher than the amount you have in your accounts.
This is rare. When those $5, $20, or $49.95 charges are enough to shift you into the red, it's a sign you have larger problems, at least temporarily. But the times they become an issue are exactly the times you need to have fewer problems, not more.
Communication is the best fix for this issue. Make sure that anybody who has the ability to use a company card or make other spending decisions knows about the fee policies associated with each account. Similarly, communicate clearly with your vendors about any and all fees so you know exactly what to expect with any automatic payment.
Theoretically, avoiding overdraft fees is a simple matter of spending less money than you have. However, the complexity of modern banking can make that difficult even for a small business's finances. When you add all the moving parts and added complications of a business's books, this issue becomes more common than many people would think. Fortunately, knowing these common mistakes and how to avoid them is a step in the right direction.