What Is Average Balance?
The average balance is the balance on a loan or deposit account averaged over a given period, usually daily or monthly.The daily or monthly average balance is calculated using multiple closing balances over the selected period of time.
A simple average balance between a beginning and ending date is calculated by adding the beginning balance and the ending balance together, then dividing that amount by two.
Key Takeaways
- The average balance is the average amount of money held in an account, or due on a loan, over a set period of time.
- The average daily balance is used by credit card companies to calculate interest charges on your outstanding balance.
- Average monthly balances are used by banks in deposit accounts and by creditors to assess stability with income and spending.
How Average Balance Is Used
Average daily balance is most commonly used by credit card companies to calculate monthly finance charges. To find your average daily credit card balance, add the total balance due at the end of each day in a given period of time, and then divide the sum by the number of calendar days in that period.The interest rate on the credit card is then multiplied by your average daily balance.
Average monthly balance is commonly used by banks in order to determine whether or not a client is meeting required account balance minimums (and can avoid being charged a fee for not meeting the minimum). An average monthly balance takes the closing balance at the end of each day and divides it by the number of calendar days in the given month for its calculation.
Creditors use the average monthly balance to assess a borrower's income stability when assessing loan eligibility. Large fluctuations in the average monthly balance of bank accounts can signal to a creditor that a borrower has an inconsistent income stream or has volatile spending habits. These factors may lead a creditor to deem an applicant a risky borrower.
For investors who trade on margin accounts, the average balance may be used to determine margin requirements, or any margin calls that the brokerage makes.
Average Balance Example
This is an example of how credit card companies calculate average daily balance. By law, credit card companies must show how they calculate finance charges. Thus, to charge interest “daily,” credit card companies must show how they calculate your average daily balance.
Assume you have a $1,000 balance on your credit card as of January 1. On January 10, you make a $400 purchase. Your payment is due on January 18, and you make a $700 payment. Then on January 25, you make a $1,000 purchase, followed by a $500 payment on January 28.
| Date | Ending Balance |
| Jan 1 | 1,000.00 |
| Jan 2 | 1,000.00 |
| Jan 3 | 1,000.00 |
| Jan 4 | 1,000.00 |
| Jan 5 | 1,000.00 |
| Jan 6 | 1,000.00 |
| Jan 7 | 1,000.00 |
| Jan 8 | 1,000.00 |
| Jan 9 | 1,000.00 |
| Jan 10 | 1,400.00 |
| Jan 11 | 1,400.00 |
| Jan 12 | 1,400.00 |
| Jan 13 | 1,400.00 |
| Jan 14 | 1,400.00 |
| Jan 15 | 1,400.00 |
| Jan 16 | 1,400.00 |
| Jan 17 | 1,400.00 |
| Jan 18 | 700.00 |
| Jan 19 | 700.00 |
| Jan 20 | 700.00 |
| Jan 21 | 700.00 |
| Jan 22 | 700.00 |
| Jan 23 | 700.00 |
| Jan 24 | 700.00 |
| Jan 25 | 1,700.00 |
| Jan 26 | 1,700.00 |
| Jan 27 | 1,700.00 |
| Jan 28 | 1,200.00 |
| Jan 29 | 1,200.00 |
| Jan 30 | 1,200.00 |
| Jan 31 | 1,200.00 |
| Total | $35,000.00 |
Your average daily balance for the month of January is:
$1,000 * 9 days (January 1 to January 9) = $9,000
$1,400 * 8 days (January 10 to January 17) = $11,200
$700 * 7 days (January 18 to January 24) = $4,900
$1,700 * 3 days (January 25 to January 27) = $5,100
$1,200 * 4 days (January 28 to January 31) = $4,800
To calculate average daily balance, take the sum of all these ending balances and divide by the number of days in your period. In this example, there are 31 days in the month of January. The average daily balance of the above example is $1,129.03 ($35,000 / 31).
As an expert in finance and accounting, with a robust understanding of the intricacies of financial concepts, I can confidently delve into the topic of "Average Balance" and shed light on its applications, calculations, and significance in various financial contexts.
The concept of average balance pertains to the mean value of the balance on a loan or deposit account over a specified period, typically daily or monthly. The daily or monthly average balance is derived by calculating the mean of multiple closing balances over the chosen timeframe. This is achieved by summing the beginning and ending balances and dividing by two for a simple average balance.
Now, let's dissect the key takeaways from the provided article:
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Definition of Average Balance:
- The average balance represents the mean amount of money held in an account or owed on a loan during a designated period.
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Usage of Average Balance:
- Credit Card Companies: Employ the average daily balance to compute monthly finance charges. This involves adding the daily balances over a specific period and dividing the sum by the number of calendar days. The interest rate is then applied to the average daily balance.
- Banks: Utilize the average monthly balance to assess compliance with required account balance minimums. This is calculated by dividing the closing balance at the end of each day by the number of calendar days in the month.
- Creditors: Employ the average monthly balance to evaluate a borrower's income stability, helping assess loan eligibility.
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Example Illustration:
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The article provides a detailed example of how credit card companies calculate average daily balance, emphasizing the importance of transparency in displaying finance charge calculations.
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Using a hypothetical scenario, it demonstrates the calculation of the average daily balance for each day in January, considering different transactions and payments. The total of these daily balances is then divided by the number of days in the period to derive the average daily balance.
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In the example, the average daily balance for January is calculated as $1,129.03 ($35,000 / 31 days).
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In conclusion, understanding average balance is crucial in financial management, whether for credit card users, account holders, or investors trading on margin accounts. It serves as a key metric for assessing financial stability, determining fees, and calculating interest charges. The provided example further illustrates the practical application of average balance calculations in a real-world scenario.
