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:

1. Gather all the daily balances for the month.
2. Add up all the daily balances.
3. Divide the total balance for the month by the number of days in the month.
4. 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.