American Express: Overdraft Protection — a Last Resort Best Avoided

Knowledge Partners 091016 Few goofs are as painful as bounced checks, with their attendant hassles and embarrassments. Bank overdraft protection is one option for small-business owners to handle temporary gaps in cash flow.

Banks won’t necessarily cover a shortfall automatically. If you haven’t signed up for overdraft protection — or if you don’t have a small-business account that includes it — your checks could bounce. Overdraft protection, also known as bounced-check protection, can be seen as a sort of intentional short-term loan with the bank covering your check until you make your next deposit, or linking your checking account to another account or a credit card, so that available funds are automatically transferred if needed.

The service can help to shield you from further credit problems, not to mention the extra work and other adverse consequences of having a check bounce or a transaction denied. In return, you pay a fee for the service.

But using overdraft protection as a short-term financing solution scores low points from small-business advisers. While the service can help out in a pinch, overdraft protection is a lousy strategy, these experts say, and best avoided. Why? For starters, costs can be substantial. Critics view the service as little more than high-priced credit. Fees average $34 per transaction, which is less than the usual penalty for a bounced check (at least until recently). “The extra fees can be large and can mount up fast before you know it,” says Therese Flaherty, director of the Wharton Small Business Development Center in Philadelphia.

And having the service may not guarantee that the bank automatically will pay the overdraft.

What’s more, relying on overdraft protection can be read as a signal that a business owner doesn’t have a good handle on his or her cash management. These snafus are completely avoidable if you keep track of transactions and balances, which is easier than ever with online banking and other relatively simple-to-use small-business accounting software.

For many business owners, time is the big issue. Often their focus is: “Get the money, fast and easy,” Flaherty says. Most business owners aren’t expert in finance, they’re experts in their business. “People don’t optimize,” she adds. “People do the best they can.” If you’ve been relying on bank overdraft protection to cover temporary cash shortfalls, it’s worthwhile to look for another financing alternative. Here are a few options to explore:

  • a micro-finance loan;
  • a line of credit that automatically kicks in when cash is short; an arrangement with a supplier that agrees not charge you for a short-term loan; or
  • a lease for a piece of equipment so that you’re not paying for it all up front.

Also, talk with other owner-operators in the same business as yours, or a similar one, and find out what works for them. “Make a little bit of time for discovery,” says Flaherty.

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