Cash overdrafts: accounting for negative cash

Cash overdrafts: accounting for negative cash

From Accounting Weekly: As an accounting professional, it’s always a challenge to best present your client or employer’s month-end and year-end balance sheets. On the one hand, you want to show your client or employer in a positive light. But you also need to maintain the integrity of the balance sheet.

One of the issues that businesses usually grapple with is how to account for a negative cash balance. The responsibility often tends to fall on the shoulders of accounting professionals.

So, it’s a good idea to be savvy about this common issue that impacts most businesses at some point or the other.

What Exactly Is a Negative Cash Balance?

Say your client owes R50,000 to vendors and has written cheques for this amount, which are yet to be encashed. Yet, the amount in the client’s account is just R20,000. This means that the client has a negative cash balance of R30,000.

If the bank account is infused with the pending funds to meet the balance amount of R20,000 before the checks are encashed, then the negative cash balance plummets to zero.

Why do businesses have negative cash balances?

Cash flow is a real problem faced by many businesses. Sometimes a business will write cheques on the assumption that the account has enough funds or that the funds will clear shortly. Sometimes businesses write cheques knowingly when the balance cannot meet the amount on the cheques.

This will result in the bank issuing an overdraft statement. Unlike when a retail banking consumer makes an overdraft, which can be paid back, a business must record the overdraft in its balance sheet and report it to investors.

Bank fees and charges 

When a business presents the checks in a negative cash balance scenario, the bank will accept the check, covering the overdraft. However, they will charge fees and a high interest rate for the services. This is because they are essentially offering a short-term loan.

The average overdraft fee in the United States in 2020 was around 33.47 US dollars. This was up from 21.57 US dollars in 2000.

Alternatively, if the business has multiple accounts, the bank may transfer funds rather than provide a loan. In this case, they will charge a convenience fee for the service. Either way, the details of the bank overdraft will need to be reported in an overdraft statement, which will need to be recorded in the balance sheet.

Accounting for a cash overdraft 

There are several approaches to treating a negative cash balance and bank overdraft in the best way.

Most businesses strive to avoid showing it on the balance sheet. This is done by shifting the overdrawn cheques into a “liability” account and setting up the entry to automatically reverse. By doing so, the cash withdrawal is shifted back into the cash account at the start of the next reporting period.

The liability account approach comes with two options, where the overdrawn amount can be mentioned, as follows:

Create a separate head

One approach is to place the overdrawn amount in a separate account, titled “Overdrawn cheques” or “Cheques paid exceeding cash”. In theory, this is the right approach.

However, overdrawn cash drafts are usually smaller in amount, and hence, having extra heads tends to make the ledger look cluttered. As such, accountants choose to avoid this route.

Place under “Accounts Payable”

Accounts payable is essentially the amount owed by the company to its vendors, distributors, and other partners. Typically, it is an asset or operating expense, and a bank overdraft amount can be treated as the same. If the overdraft amount is played under this head, the accounts payable detail report will no longer match the total account balance.

However, if overdrawn cheques are a once-in-a-while occurrence, this route is okay, as long as the entry automatically reverses when the overdrawn amount is paid in a brief period.

What do bank overdrafts say about a business?

The outstanding overdraft amount lent by high street banks in 2017 in the United Kingdom (UK) was 6538 million GBP, up from 4676 million GBP in 1997!

As an accounting professional, it is good to understand the significance of a company’s zero cash balance. Typically, it can reflect the following issues:

  • The business has probably resorted to bank overdrafts. This puts the company’s liquidity into question, which can be a concern to investors and stakeholders.
  • The business might be writing cheques to indicate to suppliers that they are being created on time. However, they might be holding them back until there is enough cash in the bank account so they do not bounce. This is a poor practice and results in diminishing trust with suppliers.
  • The business might become too dependent on bank overdrafts to meet its operational expenses. This means it might be consistently suffering from cash problems. It can be due to poor cash flow management, lack of a solid business model, and lack of discipline.

Knowledge is power

It is advisable for accounting professionals to be alert to these trends. If a business is continuously leveraging bank overdrafts, it can signify major irregularities as well as a culture of poor business practices.

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