The available balance is the balance in checking or on-demand accounts that is free for use by the customer or account holder. These are funds that are available for immediate use, and includes deposits, withdrawals, transfers, and any other activity that has already cleared to or from the account. A credit card account’s available balance is normally referred to as available credit.
An account holder’s available balance may be different from the current balance. The current balance generally includes any pending transactions that haven’t been cleared.
The available balance is different from the current balance, which includes any pending transactions.
Understanding Available Balance
As noted above, the available balance represents the funds available for immediate use in a customer’s account. This balance is updated continuously throughout the day. Any activity that takes place in the account—whether that’s a transaction done through the teller, an automated teller machine (ATM), at a store, or online—affects this balance. It does not include any pending transactions that have yet to clear.
When you log into your online banking portal, you will normally see two balances at the top: The available balance and the current balance. The current balance is what you have in your account all the time. This figure includes any transactions that have not cleared such as checks.
Depending on both the issuing bank and the receiving bank’s policies, check deposits may take anywhere from one to two days to clear. This process may take much longer if the check is drawn on a non-bank or foreign institution. The time between when a check is deposited and when it is available is often called the float time.
A customer’s available balance becomes important when there is a delay in crediting funds to an account. If an issuing bank has not cleared a check deposit, for example, the funds will not be available to the account holder, even though they may show up in the account’s current balance.
Using the Available Balance
Customers can use the available balance in any way they choose, as long as they don’t exceed the limit. They should also take into consideration any pending transactions that haven’t been added or deducted from the balance. A customer may be able to withdraw funds, write checks, do a transfer, or even make a purchase with their debit card up to the available balance.
For example, your bank account balance can be $1,500, but your available balance may only be $1,000. That extra $500 may be due to a pending transfer to another account for $350, an online purchase you made for $100, a check you deposited for $400 that hasn’t cleared yet because the bank put it on hold, and a pre-authorized payment for your car insurance for $450. You can use any amount up to $1,000 without incurring any extra fees or charges from your bank. If you go beyond that, you may go into overdraft, and there may be issues with the pending transactions.
Key Takeaways
The available balance is the balance available for immediate use in a customer’s account.
This balance includes any withdrawals, transfers, checks, or any other activity that has already been cleared by the financial institution.
The available balance is different from the current balance which accounts for all pending transactions.
Customers can use any or all of the available balance as long as they don’t exceed it.
Available Balance and Check Holds
Banks may decide to place holds on checks under the following circumstances, which affect your available balance:
If the check is above $5,000, the bank can place a hold on whatever amount exceeds $5,000. However, said amount must be made available within a reasonable time, usually two to five business days.
Banks may hold checks from accounts that are repeatedly overdrawn. This includes accounts with a negative balance on six or more banking days in the most recent six-month period and account balances that were negative by $5,000 or more two times in the most recent six-month period.
If a bank has reasonable cause to doubt the collectibility of a check, it can place a hold. This can occur in some instances of postdated checks, checks dated six (or more) months prior, and checks that the paying institution deemed it will not honor. Banks must provide notice to customers of doubtful collectibility.
A bank may hold checks deposited during emergency conditions, such as natural disasters, communications malfunctions, or acts of terrorism. A bank may hold such checks until conditions permit it to provide the available funds.
Banks may hold deposits into the accounts of new customers, who are defined as those who have held their accounts for less than 30 days. Banks may choose an availability schedule for new customers.
Banks may not hold cash or electronic payments, along with the first $5,000 of traditional checks that are not in question. On July 1, 2018, new amendments to Regulation CC—Availability of Funds and Collection of Checks—issued by the Federal Reserve took effect to address the new environment of electronic check collection and processing systems, including rules about remote deposit capture and warranties for electronic checks and electronic returned checks.
Special Considerations
There are cases that can affect your account balance—both negatively and positively—and how you can use it. Electronic banking makes our lives easier, allowing us to schedule payments and allow for direct deposits at regular intervals. Remember to keep track of all your pre-authorized payments—especially if you have multiple payments coming out at different times every month. And if your employer offers direct deposit, take advantage of it. Not only does it save you a trip to the bank every payday, but it also means you can use your pay right away.
The 3-6-3 rule is a slang term that refers to an unofficial practice in the banking industry in the 1950s, 1960s, and 1970s that was the result of non-competitive and simplistic conditions in the industry.
The 3-6-3 rule describes how bankers would supposedly give 3% interest on their depositors’ accounts, lend the depositors money at 6% interest, and then be playing golf by 3 p.m. In the 1950s, 1960s, and 1970s, a huge part of a bank’s business was lending out money at a higher interest rate than what it was paying out to its depositors (as a result of tighter regulations during this time period).
Key Takeaways
The 3-6-3 rule is a slang term that refers to an unofficial practice in the banking industry, specifically in the 1950s, 1960s, and 1970s, which was the result of non-competitive and simplistic conditions in the industry.
The 3-6-3 rule describes how bankers would supposedly give 3% interest on their depositors’ accounts, lend the depositors money at 6% interest, and then be playing golf by 3 p.m.
After the Great Depression, the government implemented tighter banking regulations, which made it more difficult for banks to compete with each other and limited the scope of the services they could provide clients; as a whole, the banking industry became stagnant.
Understanding the 3-6-3 Rule
After the Great Depression, the government implemented tighter banking regulations. This was partially due to the problems–namely corruption and a lack of regulation–that the banking industry faced leading up the economic downturn that precipitated the Great Depression. One result of these regulations is that it controlled the rates at which banks could lend and borrow money. This made it difficult for banks to compete with each other and limited the scope of the services they could provide clients. As a whole, the banking industry became more stagnant.
With the loosening of banking regulations and the widespread adoption of information technology in the decades after the 1970s, banks now operate in a much more competitive and complex manner. For example, banks may now provide a greater range of services, including retail and commercial banking services, investment management, and wealth management.
For banks that provide retail banking services, individual customers often use local branches of much larger commercial banks. Retail banks will generally offer savings and checking accounts, mortgages, personal loans, debit/credit cards, and certificates of deposit (CDs) to their clients. In retail banking, the focus is on the individual consumer (as opposed to any larger-sized clients, such as an endowment).
Banks that provide investment management for their clientele typically manage collective investments (such as pension funds) as well as overseeing the assets of individual customers. Banks that work with collective assets may also offer a wide range of traditional and alternative products that may not be available to the average retail investor, such as IPO opportunities and hedge funds.
For banks that offer wealth management services, they may cater to both high net worth and ultra-high net worth individuals. Financial advisors at these banks typically work with clients to develop tailored financial solutions to meet their needs. Financial advisors may also provide specialized services, such as investment management, income tax preparation, and estate planning. Most financial advisors aim to attain the Chartered Financial Analyst (CFA) designation, which measures their competency and integrity in the field of investment management.
The asset coverage ratio is a financial metric that measures how well a company can repay its debts by selling or liquidating its assets. The asset coverage ratio is important because it helps lenders, investors, and analysts measure the financial solvency of a company. Banks and creditors often look for a minimum asset coverage ratio before lending money.
Key Takeaways
The asset coverage ratio is a financial metric that measures how well a company can repay its debts by selling or liquidating its assets.
The higher the asset coverage ratio, the more times a company can cover its debt.
Therefore, a company with a high asset coverage ratio is considered to be less risky than a company with a low asset coverage ratio.
Understanding the Asset Coverage Ratio
The asset coverage ratio provides creditors and investors with the ability to gauge the level of risk associated with investing in a company. Once the coverage ratio is calculated, it can be compared to the ratios of companies within the same industry or sector.
It’s important to note that the ratio is less reliable when comparing it to companies of different industries. Companies within certain industries may typically carry more debt on their balance sheet than others.
For example, a software company might not have much debt while an oil producer is usually more capital intensive, meaning it carries more debt to finance the expensive equipment, such as oil rigs but then again has assets on its balance sheet to back the loans.
Asset Coverage Ratio Calculation
The asset coverage ratio is calculated with the following equation:
In this equation, “assets” refers to total assets, and “intangible assets” are assets that can’t be physically touched, such as goodwill or patents. “Current liabilities” are liabilities due within one year, and “short-term debt” is debt that is also due within one year. “Total debt” includes both short-term and long-term debt. All of these line items can be found in the annual report.
How the Asset Coverage Ratio is Used
Companies that issue shares of stock or equity to raise funds don’t have a financial obligation to pay those funds back to investors. However, companies that issue debt via a bond offering or borrow capital from banks or other financial companies have an obligation to make timely payments and, ultimately, pay back the principal amount borrowed.
As a result, banks and investors holding a company’s debt want to know that a company’s earnings or profits are sufficient to cover future debt obligations, but they also want to know what happens if earnings falter.
In other words, the asset coverage ratio is a solvency ratio. It measures how well a company can cover its short-term debt obligations with its assets. A company that has more assets than it does short-term debt and liability obligations indicates to the lender that the company has a better chance of paying back the funds it lends in the event company earnings can not cover the debt.
The higher the asset coverage ratio, the more times a company can cover its debt. Therefore, a company with a high asset coverage ratio is considered to be less risky than a company with a low asset coverage ratio.
If earnings are not enough to cover the company’s financial obligations, the company might be required to sell assets to generate cash. The asset coverage ratio tells creditors and investors how many times the company’s assets can cover its debts in the event earnings are not enough to cover debt payments.
Compared to debt service ratio, asset coverage ratio is an extreme or last recourse ratio because the assets coverage is an extreme use of the assets’ value under a liquidation scenario, which is not an extraordinary event.
Special Considerations
There is one caveat to consider when interpreting the asset coverage ratio. Assets found on the balance sheet are held at their book value, which is often higher than the liquidation or selling value in the event a company would need to sell assets to repay debts. The coverage ratio may be slightly inflated. This concern can be partially eliminated by comparing the ratio against other companies in the same industry.
Example of the Asset Coverage Ratio
For example, let’s say Exxon Mobil Corporation (XOM) has an asset coverage ratio of 1.5, meaning that there are 1.5x’s more assets than debts. Let’s say Chevron Corporation (CVX)–which is within the same industry as Exxon–has a comparable ratio of 1.4, and even though the ratios are similar, they don’t tell the whole story.
If Chevron’s ratio for the prior two periods was .8 and 1.1, the 1.4 ratio in the current period shows the company has improved its balance sheet by increasing assets or deleveraging–paying down debt. Conversely, let’s say Exxon’s asset coverage ratio was 2.2 and 1.8 for the prior two periods, the 1.5 ratio in the current period could be the start of a worrisome trend of decreasing assets or increasing debt.
In other words, it’s not enough to merely analyze one period’s asset coverage ratio. Instead, it’s important to determine what the trend has been over multiple periods and compare that trend with like companies.
Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax collection entities. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company’s operations, financial position, and cash flows.
Key Takeaways
Regardless of the size of a business, accounting is a necessary function for decision making, cost planning, and measurement of economic performance.
A bookkeeper can handle basic accounting needs, but a Certified Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks.
Two important types of accounting for businesses are managerial accounting and cost accounting. Managerial accounting helps management teams make business decisions, while cost accounting helps business owners decide how much a product should cost.
Professional accountants follow a set of standards known as the Generally Accepted Accounting Principles (GAAP) when preparing financial statements.
Accounting is an important function of strategic planning, external compliance, fundraising, and operations management.
Investopedia / Jiaqi Zhou
How Accounting Works
Accounting is one of the key functions of almost any business. It may be handled by a bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of employees at larger companies. The reports generated by various streams of accounting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions.
The financial statements that summarize a large company’s operations, financial position, and cash flows over a particular period are concise and consolidated reports based on thousands of individual financial transactions. As a result, all professional accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical accounting experience.
History of Accounting
The history of accounting has been around almost as long as money itself. Accounting history dates back to ancient civilizations in Mesopotamia, Egypt, and Babylon. For example, during the Roman Empire, the government had detailed records of its finances. However, modern accounting as a profession has only been around since the early 19th century.
Luca Pacioli is considered “The Father of Accounting and Bookkeeping” due to his contributions to the development of accounting as a profession. An Italian mathematician and friend of Leonardo da Vinci, Pacioli published a book on the double-entry system of bookkeeping in 1494.
By 1880, the modern profession of accounting was fully formed and recognized by the Institute of Chartered Accountants in England and Wales. This institute created many of the systems by which accountants practice today. The formation of the institute occurred in large part due to the Industrial Revolution. Merchants not only needed to track their records but sought to avoid bankruptcy as well.
The Alliance for Responsible Professional Licensing (ARPL) was formed in August 2019 in response to a series of state deregulatory proposals making the requirements to become a CPA more lenient. The ARPL is a coalition of various advanced professional groups including engineers, accountants, and architects.
Types of Accounting
Accountants may be tasked with recording specific transactions or working with specific sets of information. For this reason, there are several broad groups that most accountants can be grouped into.
Financial Accounting
Financial accounting refers to the processes used to generate interim and annual financial statements. The results of all financial transactions that occur during an accounting period are summarized in the balance sheet, income statement, and cash flow statement. The financial statements of most companies are audited annually by an external CPA firm.
For some, such as publicly-traded companies, audits are a legal requirement. However, lenders also typically require the results of an external audit annually as part of their debt covenants. Therefore, most companies will have annual audits for one reason or another.
Managerial Accounting
Managerial accounting uses much of the same data as financial accounting, but it organizes and utilizes information in different ways. Namely, in managerial accounting, an accountant generates monthly or quarterly reports that a business’s management team can use to make decisions about how the business operates. Managerial accounting also encompasses many other facets of accounting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls underneath this umbrella.
Cost Accounting
Just as managerial accounting helps businesses make decisions about management, cost accounting helps businesses make decisions about costing. Essentially, cost accounting considers all of the costs related to producing a product. Analysts, managers, business owners, and accountants use this information to determine what their products should cost. In cost accounting, money is cast as an economic factor in production, whereas in financial accounting, money is considered to be a measure of a company’s economic performance.
Tax Accounting
While financial accountants often use one set of rules to report the financial position of a company, tax accountants often use a different set of rules. These rules are set at the federal, state, or local level based on what return is being filed. Tax accounts balance compliance with reporting rules while also attempting to minimize a company’s tax liability through thoughtful strategic decision-making. A tax accountant often oversees the entire tax process of a company: the strategic creation of the organization chart, the operations, the compliance, the reporting, and the remittance of tax liability.
The Accounting Profession
While basic accounting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA) in the United States.
In Canada, the three legacy designations—the Chartered Accountant (CA), Certified General Accountant (CGA), and Certified Management Accountant (CMA)—have been unified under the Chartered Professional Accountant (CPA) designation.
A major component of the accounting professional is the “Big Four”. These four largest accounting firms conduct audit, consulting, tax advisory, and other services. These firms, along with many other smaller firms, comprise the public accounting realm that generally advises financial and tax accounting.
Careers in accounting may vastly difference by industry, department, and niche. Some relevant job titles may include:
Auditor (internal or external): ensures compliance with reporting requirements and safeguarding of company assets.
Forensic Accountant: monitors internal or external activity to investigate the transactions of an individual or business.
Tax Accountant: strategically plans the optimal business composition to minimize tax liabilities as well as ensures compliance with tax reporting.
Managerial Accountant: analyzes financial transactions to make thoughtful, strategic recommendations often related to the manufacturing of goods.
Information and Technology Analyst/Accountant: maintains the system and software in which accounting records are processed and stored.
Controller: oversees the accounting functions of financial reporting, accounts payable, accounts receivable, and procurement.
As of December 2021, the average Certified Public Accountant in the United States made $101,779 per year.
The Accounting Rules
In most cases, accountants use generally accepted accounting principles (GAAP) when preparing financial statements in the U.S. GAAP is a set of standards and principles designed to improve the comparability and consistency of financial reporting across industries. Its standards are based on double-entry accounting, a method in which every accounting transaction is entered as both a debit and credit in two separate general ledger accounts that will roll up into the balance sheet and income statement.
In most other countries, a set of standards governed by the International Accounting Standards Board named the International Financial Reporting Standards (IFRS) is used.
Tax accountants overseeing returns in the United States rely on guidance from the Internal Revenue Service. Federal tax returns must comply with tax guidance outlined by the Internal Revenue Code (IRC). Tax accounts may also lean in on state or county taxes as outlined by the jurisdiction in which the business conducts business. Foreign companies must comply with tax guidance in the countries in which it must file a return.
Special Considerations
Accountants often leverage software to aid in their work. Some accounting software is considered better for small businesses such as QuickBooks, Quicken, FreshBooks, Xero, SlickPie, or Sage 50. Larger companies often have much more complex solutions to integrate with their specific reporting needs. This includes add-on modules or in-home software solutions. Large accounting solutions include Oracle, NetSuite, or Sage products.
The Accounting Cycle
Financial accountants typically operate in a cyclical environment with the same steps happening in order and repeating every reporting period. These steps are often referred to as the accounting cycle, the process of taking raw transaction information, entering it into an accounting system, and running relevant and accurate financial reports. The steps of the accounting cycle are:
Collect transaction information such as invoices, bank statements, receipts, payment requests, uncashed checks, credit card statements, or other mediums that may contain business transactions.
Post journal entries to the general ledger for the items in Step 1, reconciling to external documents whenever possible.
Prepare an unadjusted trial balance to ensure all debits and credits balance and material general ledger accounts look correct.
Post adjusting journal entries at the end of the period to reflect any changes to be made to the trial balance run in Step 3.
Prepare the adjusted trial balance to ensure these financial balances are materially correct and reasonable.
Prepare the financial statements to summarize all transactions for a given reporting period.
Cash Method vs. Accrual Method of Accounting
Financial accounts have two different sets of rules they can choose to follow. The first, the accrual basis method of accounting, has been discussed above. These rules are outlined by GAAP and IFRS, are required by public companies, and are mainly used by larger companies.
The second set of rules follow the cash basis method of accounting. Instead of recording a transaction when it occurs, the cash method stipulates a transaction should be recorded only when cash has exchanged. Because of the simplified manner of accounting, the cash method is often used by small businesses or entities that are not required to use the accrual method of accounting.
Imagine a company buys $1,000 of inventory on credit. Payment is due for the inventory in 30 days.
Under the accrual method of accounting, a journal entry is recorded when the order is placed. The entry records a debit to inventory (asset) for $1,000 and a credit to accounts payable (liability) for $1,000. When 30 days has passed and the inventory is actually paid for, the company posts a second journal entry: a debit to accounts payable (liability) for $1,000 and a credit to cash (asset) for $1,000.
Under the cash method of accounting, a journal entry is only recorded when cash has been exchanged for inventory. There is no entry when the order is placed; instead, the company enters only one journal entry at the time the inventory is paid for. The entry is a debit to inventory (asset) for $1,000 and a credit to cash (asset) for $1,000.
The difference between these two accounting methods is the treatment of accruals. Naturally, under the accrual method of accounting, accruals are required. Under the cash method, accruals are not required and not recorded.
The Securities and Exchange Commission has an entire financial reporting manual outlining reporting requirements of public companies.
Why Accounting Is Important
Accounting is a back-office function where employees may not directly interface with customers, product developers, or manufacturing. However, accounting plays a key role in the strategic planning, growth, and compliance requirements of a company.
Accounting is necessary for company growth. Without insight into how a business is performing, it is impossible for a company to make smart financial decisions through forecasting. Without accounting, a company wouldn’t be able to tell which products are its best sellers, how much profit is made in each department, and what overhead costs are holding back profits.
Accounting is necessary for funding. External investors want confidence that they know what they are investing in. Prior to private funding, investors will usually require financial statements (often audited) to gauge the overall health of a company. The same rules pertain to debt financing. Banks and other lending institutions will often require financial statements in compliance with accounting rules as part of the underwriting and review process for issuing a loan.
Accounting is necessary for owner exit. Small companies that may be looking to be acquired often need to present financial statements as part of acquisition or merger efforts. Instead of simply closing a business, a business owner may attempt to “cash-out” of their position and receive compensation for building a company. The basis for valuing a company is to use its accounting records.
Accounting is necessary to make payments. A company naturally incurs debt, and part of the responsibility of managing that debt is to make payments on time to the appropriate parties. Without positively fostering these business relationships, a company may find itself with a key supplier or vendor. Through accounting, a company can always know who it has debts to and when those debts are coming due.
Accounting is necessary to collect payments. A company may agree to extend credit to its customers. Instead of collecting cash at the time of an agreement, it may give a customer trade credit terms such as net 30. Without accounting, a company may have a hard time keeping track of who owes it money and when that money is to be received.
Accounting may be required. Public companies are required to issue periodic financial statements in compliance with GAAP or IFRS. Without these financial statements, a company may be de-listed from an exchange. Without proper tax accounting compliance, a company may receive fines or penalties.
Example of Accounting
To illustrate double-entry accounting, imagine a business sends an invoice to one of its clients. An accountant using the double-entry method records a debit to accounts receivables, which flows through to the balance sheet, and a credit to sales revenue, which flows through to the income statement.
When the client pays the invoice, the accountant credits accounts receivables and debits cash. Double-entry accounting is also called balancing the books, as all of the accounting entries are balanced against each other. If the entries aren’t balanced, the accountant knows there must be a mistake somewhere in the general ledger.
What Are the Responsibilities of an Accountant?
Accountants help businesses maintain accurate and timely records of their finances. Accountants are responsible for maintaining records of a company’s daily transactions and compiling those transactions into financial statements such as the balance sheet, income statement, and statement of cash flows. Accountants also provide other services, such as performing periodic audits or preparing ad-hoc management reports.
What Skills Are Required for Accounting?
Accountants hail from a wide variety of backgrounds. Generally speaking, however, attention to detail is a key component in accountancy, since accountants must be able to diagnose and correct subtle errors or discrepancies in a company’s accounts. The ability to think logically is also essential, to help with problem-solving. Mathematical skills are helpful but are less important than in previous generations due to the wide availability of computers and calculators.
Why Is Accounting Important for Investors?
The work performed by accountants is at the heart of modern financial markets. Without accounting, investors would be unable to rely on timely or accurate financial information, and companies’ executives would lack the transparency needed to manage risks or plan projects. Regulators also rely on accountants for critical functions such as providing auditors’ opinions on companies’ annual 10-K filings. In short, although accounting is sometimes overlooked, it is absolutely critical for the smooth functioning of modern finance.
