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What is the compensating balance?
A compensating balance is a minimum deposit that must be maintained in a bank account by a borrower. The borrower cannot use the money but is required to disclose it in the borrower’s notes attached to its financial statements.
What is an example of compensating balance?
Example of a Compensating Balance A corporation has a $5 million line of credit with a bank. The borrowing agreement states that the corporation will maintain a compensating balance in an account at the bank of at least $250,000. When the two sides of the arrangement are netted, the loan is actually $4,750,000.
What are the 2 ways of calculating compensating balances which is better?
There are two main ways of calculating a compensating balance. These are the average balance arrangement and the minimum fixed balance arrangement.
How are compensating balances classified on the balance sheet?
A compensating balance results in the borrower’s paying an effective interest rate higher than the stated rate on the debt. If restriction is legally binding, the cash is classified as either current or noncurrent (investments and funds or other assets) depending on the classification of the related debt.
Is a compensating balance an asset?
However, if it is anticipated that the cash will remain unavailable for use for more than a year, then it should be classified as a non-current asset. A compensating balance is a minimum balance that a company must maintain in an account as part of an agreement with a current or potential lender.
Is cash over and short an asset?
This cash shortfall is recorded as a debit to the cash over and short account (which is an expense) and a credit to the petty cash or cash account (which is an asset reduction).
How do you show restricted cash on a balance sheet?
If it is not expected to be used within a one-year time frame, it is classified as a non-current asset. Restricted cash typically appears on a company’s balance sheet as either “other restricted cash” or as “other assets.”
What is restricted cash on balance sheet?
Restricted cash refers to money that is held for a specific purpose and thus not available to the company for immediate or general business use. Restricted cash appears as a separate item from the cash and cash equivalents listing on a company’s balance sheet.
What account is payroll?
A payroll account is a separate bank account for your business that is strictly used for payroll. Instead of lumping all your business expenses into one account, you will pay employee wages with your payroll bank account. The money going into the payroll account will only be used for payroll.
How to calculate interest rate on a compensating balance and?
Part of the loan condition is that you deposit $25,000 in an account at the bank in return for which they cut the interest rate from 6 to 5%. This works out well for the bank. It has loaned you $150,000, but since it has your $25,000, the loan only ties up $125,000 in bank funds. You get a lower interest rate, which benefits you.
What does it mean to have a compensating balance?
When a borrower agrees to hold a compensating balance, it promises a lender to maintain a minimum balance in an account. The compensating balance required by a lender is usually a percentage of the loan balance.
How does a clothing store get a compensating balance?
The bank agrees to charge a lower interest rate on the LOC if the clothing store deposits a $30,000 compensating balance. The bank loans the clothing store’s compensating balance to other borrowers, and profits on the difference between the interest earned and the lower rate of interest paid to the clothing store.
Do you have to have a compensating balance on a line of credit?
It’s unlikely you’ll have a compensating balance. A bank may also require you to deposit a compensating balance if you request a line of credit. Rather than a $20,000 loan, a $20,000 compensating balance line of credit allows you to borrow money from the bank up to that amount whenever you need it.