Definition
The average outstanding balance is a financial term referring to the unpaid, interest-bearing balance of a loan or loan portfolio averaged over a certain period, typically a month. It’s calculated by adding the outstanding balance for each day in the period and dividing by the number of days in the period. This measure is critical in finance as it aids in determining the amount of potential revenue or risk associated with a loan or portfolio.
Phonetic
The phonetics for “Average Outstanding Balance” are:Average: /ˈæv.ər.ɪdʒ/Outstanding: /aʊtˈstæn.dɪŋ/Balance: /ˈbæl.əns/
Key Takeaways
1. Average Outstanding Balance represents the unpaid, interest-bearing balance on a loan or credit line. This is the amount of money that continues to be owed to the lender by the borrower over a certain period of time. The calculations to derive this figure involve averages, and hence the name. This figure is crucial in the finance industry as it helps in monitoring credit risk, the performance of loans and the behavior of borrowers, guiding decision-making processes for lenders.2. It’s calculated regularly for monitoring purposes. The average outstanding balance is typically calculated on a monthly, quarterly, or annual basis. Having such regular measurements allows financial institutions to effectively track and manage the credit they have extended to consumers or other businesses.3. Impacts the interest paid. The Average Outstanding Balance plays a significant part in determining the amount of interest that will accumulate on that balance. Higher average outstanding balances generally result in higher interest charges. Therefore, borrowers aim to keep their average outstanding balance as low as possible while lenders may benefit from higher balances due to the increased interest generated.
Importance
The Average Outstanding Balance is a crucial term in business/finance because it gives businesses, particularly financial institutions, a quantifiable view of the amount of unpaid balances that customers have over a given period. It is often used to calculate interest on loans and credit cards, assess the risk level of a customer or a portfolio and monitor the performance of a credit product. This measurement aids businesses in strategizing effective repayment plans and implementing appropriate credit controls. Furthermore, understanding the average outstanding balance helps businesses in decision-making processes related to revenue forecasting, resource allocation, and overall financial management. It is, therefore, an essential component in maintaining a company’s financial health.
Explanation
The average outstanding balance is a crucial metric in both business and finance as it determines the amount of money owed that remains unpaid over a certain period. Understanding this value aids in formulating effective financial strategies, as it gives a clearer perspective of the debtor’s repayment ability, credit risk and profitability. For credit card companies, this figure helps in analyzing the cardholder’s spending habits, helping them gauge the risk and potential profitability of lending to this individual. Moreover, the average outstanding balance is also valuable in the calculation of the interest on various loans and credit lines. Financial institutions or lenders use this figure to calculate the interest payments due on a loan, mortgage, or credit card balance. Borrowers, on the other hand, can use this figure to understand how their repayment habits influence the interest they have to pay over time. Thus, comprehension of your average outstanding balance can better inform financial decisions and strategies on both the lending and borrowing sides.
Examples
1. Credit Card Accounts:Assume that Jim has a credit card with a high credit limit. In the first week of the month, he spends $500 to book a hotel for his vacation, and in the second week, he spends another $1000 on flight tickets. He doesn’t make any other purchase on this card for the rest of the month. So, his average outstanding balance would be: (($500 for 30 days) + ($1000 for 15 days)) / 30 = $750. This is the average outstanding balance on his credit card for that month.2. Mortgage Loans:Let’s say Lisa took out a mortgage loan of $300,000 with a monthly repayment amount for the next 30 years. At the end of the first year, she paid $18,000 reducing the loan balance to $282,000. If we consider a simplistic example where the payments are spread throughout the year, then the average outstanding balance during that year would be the midway point of $300,000 and $282,000, which is $291,000.3. Business Line of Credit:Suppose a business has a line of credit from a bank with a limit of $50,000. The company starts the month with a $0 balance, borrows $25,000 at the beginning of the month, repays $10,000 in the middle of the month, and makes no further transactions. Then the average outstanding balance would be: (($25,000 for 15 days) + ($15,000 for 15 days)) / 30 = $20,000. This calculation would be used by the bank to calculate interest for that month.
Frequently Asked Questions(FAQ)
What is the Average Outstanding Balance?
The Average Outstanding Balance refers to the amount of unpaid balance in a loan, line of credit, or any other type of debt that is outstanding over a certain period. It is essentially the sum of the opening and closing balances of the period divided by two.
How is the Average Outstanding Balance calculated?
The Average Outstanding Balance is typically calculated by adding the beginning outstanding balance of the loan or debt for a particular period with the ending outstanding balance for the same period, and then dividing the sum by two.
Why is the Average Outstanding Balance important in finance?
The Average Outstanding Balance is critical in finance as it helps in calculating interest on loans or credit cards. Most financial institutions use it to calculate the interest you’re charged over a specific billing cycle.
Does one’s Average Outstanding Balance affect their credit score?
Yes. the Average Outstanding Balance can affect a person’s credit score. High Average Outstanding Balances could negatively impact the credit utilization ratio, an important factor in determining credit scores.
How can one reduce their Average Outstanding Balance?
Individuals can reduce their Average Outstanding Balance by making regular, on-time payments towards the debt, or by paying more than the minimum amount required each month.
When is the Average Outstanding Balance used in Business?
The Average Outstanding Balance is often used in calculating interest and also when assessing a business’s financial health. It gives an idea about the debt amount a business typically carries, which can be used to evaluate its solvency and risk to potential investors or lenders.
Does the average outstanding balance include interest?
No, the average outstanding balance refers to the base amount of debt that is outstanding. It does not include any accumulated interest unless the mortgage itself includes capitalized interest.
How often does the Average Outstanding Balance change?
The Average Outstanding Balance can change with each billing cycle, as payments are made towards the balance or additional purchases and charges are added.
Related Finance Terms
- Amortization Schedule: This is a complete table of periodic loan payments, showing the amount of principal and the amount of interest that comprise each payment until the loan is paid off at the end of its term.
- Interest Rate: This refers to the amount charged, expressed as a percentage of the principal, by a lender to a borrower for the use of assets. Variable or fixed interest rates directly affect the average outstanding balance.
- Credit Utilization Ratio: This is the amount of outstanding debt compared to a borrower’s total available credit. It’s a key component in credit score calculations.
- Minimum Payment: This is the lowest amount of money that you are required to pay on your credit card statement each month. It is exerted directly on the average outstanding balance.
- Late Payment: This refers to a payment that a borrower sends to a creditor that arrives after the scheduled due date. Late payments can negatively affect the average outstanding balance as they may incur penalties and higher interest.
