How to Calculate Average Daily Balance

Average Daily Balance (ADB) is a common financial calculation method used to determine the typical amount of money present in an account over a specific period. This method is widely applied in the financial sector to compute interest charges on credit products or interest earned on deposit accounts. Understanding ADB is important for consumers because it directly impacts the costs associated with borrowing and the earnings from savings.

Understanding Average Daily Balance

Average Daily Balance represents the mean balance of an account over a defined period, typically a billing cycle or a month. This figure is derived by summing the end-of-day balances for each day within that period and then dividing the total by the number of days in the period. Financial institutions use ADB to gain a true picture of the funds available or owed throughout the entire duration, rather than relying on a single day’s balance.

The significance of ADB extends across various financial instruments. For credit cards, it forms the basis for calculating the interest charged on outstanding balances. Similarly, banks often use the average daily balance to determine the interest paid out on savings accounts or to assess service fees on checking accounts if certain minimum balance requirements are not met.

Calculating Average Daily Balance for Credit Cards

Calculating the Average Daily Balance for credit cards involves a systematic process to account for all financial activity within a billing cycle. The first step requires tracking the outstanding balance at the close of each day throughout the entire billing period. This includes the starting balance, any new purchases, cash advances, fees, and any payments or credits applied to the account.

Then, sum the end-of-day balances for each day in the billing cycle and divide by the total number of days to arrive at the Average Daily Balance. This calculated ADB is then used by the credit card issuer to determine the finance charge by multiplying it by the daily periodic rate and the number of days in the billing period.

Consider a credit card with a 30-day billing cycle. If the initial balance is $1,000 for the first 10 days, then a $100 purchase increases the balance to $1,100 for the next 10 days, and a $50 payment reduces it to $1,050 for the final 10 days. To calculate the ADB, you would sum ($1,000 x 10 days) + ($1,100 x 10 days) + ($1,050 x 10 days) = $10,000 + $11,000 + $10,500 = $31,500. Dividing this total by 30 days yields an Average Daily Balance of $1,050.

Calculating Average Daily Balance for Bank Accounts

The calculation of Average Daily Balance for bank accounts, such as savings or checking accounts, follows a similar principle to that of credit cards. The primary difference lies in the application of the calculated ADB, which is typically used for earning interest or avoiding service fees. To begin, you need to record the end-of-day balance for each day within the relevant period, which could be a month or a quarter.

This process involves noting all deposits, withdrawals, and other daily transactions that impact the account balance. After recording all daily balances, sum them and divide by the total number of days in the period to determine the Average Daily Balance.

For instance, if a savings account starts a 30-day month with $500, a $200 deposit on day 10 brings the balance to $700, and a $100 withdrawal on day 20 changes it to $600. The daily balances would be $500 for 9 days, $700 for 10 days, and $600 for 11 days. The sum would be ($500 x 9) + ($700 x 10) + ($600 x 11) = $4,500 + $7,000 + $6,600 = $18,100. Dividing $18,100 by 30 days results in an Average Daily Balance of $603.33. Banks often use this ADB to calculate the interest accrued on savings, or to determine if a checking account meets a minimum balance requirement to waive monthly service fees.