What Is An Average Daily Balance?
The average daily balance indicates an account’s average balance over a given period. To determine the average daily balance, all the daily balances in the billing cycle are aggregated; the result is divided by the number of days in the given period. This procedure aids in ensuring that the interest charge or credit is commensurate with the total amount of debt or credit incurred throughout the period.
This method is commonly used for credit cards to determine interest charges and find the average balance for the entire year. The credit card company tracks the total balance owed at the end of each day. For convenience, an average daily balance calculator can also be used.
Table of contents
- Average daily balance is a way of computing interest where the total amount owed by a customer per day is divided by the number of days in the given period.
- Customers should keep an eye on the mean daily balance—outstanding balances on their credit cards.
- Also, the sooner the payment is made, the lower the mean average balance for their next billing cycle. This way, customers can cut costs on associated charges.
- The mean daily balance is determined using the following formula:
Average Daily Balance Method Explained
The average daily balance is a number that indicates the average balance of an account over a given period. Using the posting date of financial accounting documents as a reference point, this component enables companies to compute the mean daily balances for intra-month dates.
In addition, several other important metrics, such as the year-to-date average balance and annual percentage rate, are computed using average monthly activity data. This element enables efficient and precise computation of the mean daily balance for any part of the year.
This accounting method is common with credit card companies; they calculate interest charges on credit cards based on the total balance owed—at the end of each day.
For computational purposes, the balance for each day is calculated by adjusting the ‘total new balance.’ This includes payments, credit, and cash withdrawals. It also includes purchases of goods and services made on sales drafts and cash withdrawal drafts received before the closing date (billing period).
The calculation considers the due balance and daily investment when determining the average daily amount. But at the end of every week, month, quarter, or year, the daily investment (billing period) is given more weightage than the closing figure. This approach is adopted by lenders and borrowers, especially when compounding occurs.
The average daily balance formula is as follows.
The average daily amount is calculated by segregating the outstanding amount for each day during the billing period. Then the result is divided by the total number of days in the billing period. Finally, the average daily amount is calculated using the following formula.
Keeping a check on the average daily amount can alert a customer if there are any outstanding dues on their credit card. In addition, the sooner the payment is made, the lower the average daily amount for their next billing cycle. This way, credit card users can also cut costs on associated charges.
How To Calculate?
Let us look at an example to understand how to calculate average daily balances.
Dave owns a credit card with an annual percentage rate (APR) of 10%. The billing cycle spans 25 days. The card had a balance at the beginning of his new billing cycle. On the 8th day of the billing cycle, he used the card to make a new payment of $500.
Consecutively, he made another payment on the 21st day of the billing cycle. Dave paid $150 to a vendor against the card’s outstanding balances.
Thus, Dave’s daily closing amount for each day of the credit card billing cycle is as follows:
- Days 1–7: The daily closing amount was $100.
- Days 8–20: The daily closing amount was $600 ($100 + $500 payment).
- Day 21–25: The daily closing amount was $450 (following the $50 payment).
The average daily amount is determined by adding the balances for each day (billing cycle). Then, the result is divided by the total by the number of days in the cycle. Now we apply the given values to the following formula:
- Average Daily Amount = [($100 spread across seven days) + ($600 spread across thirteen days) + ($450 spread across five days)] /25 (total billing cycle span)
- Average Daily Amount = 100*7 + 600*13 + 450*5 / 25
- Average Daily Amount = (700 + 9600 + 2250) / 25
- Average Daily Amount = 12550 / 25
- Average Daily Amount = 502
Thus, Dave’s average closing amount is 502.
Frequently Asked Questions (FAQs)
Just like a bank account, the average daily amount is calculated by dividing the sum of the total daily amount by the number of days in the billing cycle. The average daily amount refers to daily transactions occurring on an individual’s account. An average daily balance calculator can also determine the mean daily balance.
Generally, any fee paid to borrow money is referred to as a “finance charge.” This may involve fees imposed by lenders, such as interest rates and other related fees. The average daily amount is multiplied by the monthly interest rate to determine the customer’s finance charge.
The calculation of the daily amount is similar to the mean daily amount. There is one difference, though, the mean amount considers the cumulative average of each day. In contrast, the daily closing amount method does not consider the mean. Instead, each day’s closing amount is multiplied by 1/365.
This article has been a guide to what is Average Daily Balance. Here, we explain it in detail with its formula and how to calculate it. You can learn more about it from the following articles –