Definition of Overdraft Balance
An overdraft balance occurs when money is withdrawn from a bank account and the available balance goes below zero. In simple terms, it represents the negative balance in a customer’s account, where the bank allows withdrawals beyond the available funds, often up to a certain limit. This facility is typically granted by banks to help customers or businesses manage short-term liquidity needs.
Meaning of Overdraft Balance in Detail
The overdraft balance reflects the short-term borrowing provided by the bank to an account holder. Instead of declining a transaction when there are insufficient funds, the bank honors the withdrawal and creates a negative balance in the account. The account holder is then liable to repay the overdraft amount along with applicable interest and charges.
Overdraft balances are common in both personal and business banking, serving as a flexible credit tool. For businesses, it ensures continuity in operations when immediate cash flow is required, while for individuals, it prevents transaction rejections during emergencies.
Sub-Sections Breakdown
Banking Context: Overdraft balance is the excess amount withdrawn beyond the account balance.
Accounting Context: It is treated as a liability in the books of account.
Economics & Business Context: It functions as a short-term credit facility, supporting working capital and liquidity management.
Statistics Context: Data on overdraft balances is often analyzed in financial studies to measure household or corporate debt trends.
Formula / Calculation of Overdraft Balance
Overdraft Balance = Total Withdrawals − Available Balance
Where:
Total Withdrawals = Amount withdrawn or spent from the account
Available Balance = Funds present in the account before overdraft
Example Calculation
Suppose a business has Rs. 10,000 in its bank account. It issues a cheque of Rs. 15,000.
Total Withdrawals = Rs. 15,000
Available Balance = Rs. 10,000
Overdraft Balance = Rs. 15,000 − Rs. 10,000 = Rs. 5,000
Thus, the account shows an overdraft balance of Rs. 5,000.
Accounting Journal Entry (for Overdraft Balance)
When a bank grants overdraft:
Bank Account Dr. To Bank Overdraft Account
Example: Business withdraws Rs. 5,000 beyond its balance:
Bank A/c Dr. 5,000 To Bank Overdraft A/c 5,000
This entry shows overdraft as a liability.
Detailed Illustration with Calculation
Suppose XYZ Ltd. has Rs. 50,000 in its account. It issues payments worth Rs. 70,000. The overdraft facility allows a limit of Rs. 30,000.
Account Balance = Rs. 50,000
Payment Issued = Rs. 70,000
Excess Withdrawal = Rs. 20,000
Overdraft Balance = Rs. 20,000
Journal Entry:
Bank A/c Dr. 20,000 To Bank Overdraft A/c 20,000
This Rs. 20,000 will be shown under current liabilities in the balance sheet.
Key Features / Characteristics
Negative account balance
Short-term borrowing facility
Subject to limits set by bank
Interest is charged on the overdraft amount
Can be secured (against collateral) or unsecured
Flexible repayment without fixed EMIs
Importance in Business
Helps businesses manage working capital needs
Prevents dishonor of cheques and payments
Provides quick access to funds
Acts as a financial safety net
Advantages and Disadvantages
Advantages:
Immediate access to funds
Flexible repayment structure
Helps maintain creditworthiness
Disadvantages:
High interest rates compared to loans
Can lead to debt traps if misused
Not suitable for long-term financing
Usage of Overdraft Balance
Individuals use it during emergencies
Businesses use it for covering temporary cash shortages
Banks use overdraft facilities to provide short-term credit support
Case Studies
Small Business Example: A retail shop facing seasonal cash shortages uses overdraft to pay suppliers before festive sales. Once sales revenue arrives, the overdraft is cleared.
Corporate Example: Large corporations like Tata Group have overdraft agreements to ensure liquidity when undertaking large projects.
Household Example: Individuals with salary accounts often use overdraft to cover expenses before payday.
Practical Example
Mr. A has Rs. 2,000 in his account. He withdraws Rs. 5,000 using overdraft.
Available Balance = Rs. 2,000
Withdrawn Amount = Rs. 5,000
Overdraft Balance = Rs. 3,000 (to be repaid with interest)
Common Mistakes / Misunderstandings
Assuming overdraft is free money (interest applies)
Using overdraft for long-term investments
Not tracking overdraft limit leading to penalty charges
Real-Life Applications
Used by companies for working capital management
Used by households during emergencies
Banks rely on overdraft balances as a revenue source via interest charges
Legal implications: Non-repayment can lead to recovery proceedings and negative credit ratings
FAQs
Q1: Is overdraft balance a loan?
Yes, it is a type of short-term loan from the bank.
Q2: Is overdraft balance shown as asset or liability?
It is shown as a liability in accounting books.
Q3: Do all bank accounts have overdraft facility?
No, it is provided only to eligible account holders.
Q4: What is the interest rate on overdraft balance?
It varies by bank but is generally higher than normal loans.
Q5: Can overdraft affect credit score?
Yes, failure to repay overdraft on time can lower credit scores.
Expert Tip from Learn with Manika
Always treat overdraft as a financial backup, not as regular income. Use it wisely for short-term liquidity needs, and repay quickly to avoid high interest costs.
Related Terms
- Cash Credit
- Working Capital
- Current Liabilities
- Bank Loan
- Liquidity Management