Average Daily Balance Method
The average daily balance method calculates average daily balance for a loan account by taking the sum of all the daily balances in a particular month and dividing the sum by the number of days in the month.
Formula:
Average daily balance = Total balance for the month / Number of days in the month
Steps:
- Gather all the daily balances for the month.
- Add up all the daily balances.
- Divide the total balance for the month by the number of days in the month.
- The result is the average daily balance for the month.
Example:
Suppose you have a loan account with the following daily balances for the month of January:
- January 1: $10,000
- January 2: $10,500
- January 3: $11,000
- January 4: $10,700
- January 5: $10,200
To calculate the average daily balance, we first add up all the daily balances:
Total balance for January = $10,000 + $10,500 + $11,000 + $10,700 + $10,200 = $52,400
Next, we divide the total balance for January by the number of days in January (5):
Average daily balance = $52,400 / 5 = $10,480
Therefore, the average daily balance for January is $10,480.
Benefits:
- Easy to calculate
- Provides a good approximation of the average balance
- Can be used for loans with variable interest rates
Drawbacks:
- Does not account for interest accrual on different days
- Can be inaccurate for loans with a lot of payments or withdrawals
- Does not provide information about the timing of payments or withdrawals
Overall:
The average daily balance method is a simple and effective way to calculate the average daily balance for a loan account. However, it does have some drawbacks that should be considered when interpreting the results.
