What do negative cash balances mean?

1. Reasons for negative cash balances

Sometimes companies have negative cash balances on their trial balances at a period end. What do such negative balances mean?

There are two possible reasons for a negative cash balance.

a) A bank accepted a company's checks without sufficient funds in the company's bank account

A company has a bank account. The company issues (cuts) checks to its vendors against the cash balance in the bank account. Suppose during December 2009, the company issued checks amounting to $45,000. All checks were presented by the vendors to the bank for clearance. Let's also assume that the company only had $40,000 in the bank account. So, $5,000 of checks could not be settled with the available cash in the bank. The bank, however, had an agreement with the company whereby the bank accepted the company's checks from the vendors and settled them by creating an overdraft. Therefore, at December 31 the company had zero cash and a negative balance representing an overdraft.

In this case, when the company issued checks, it debited Accounts Payable and credited Cash for $45,000. As all checks ($45,000) cleared by the end of December, no adjustments were needed in relation to outstanding checks. However, because the bank account was $5,000 short, the bank shows a negative cash balance (overdraft), and so do the company records ($40,000 less $45,000).

b) A company issued checks in excess of a cash balance in a bank

Let's assume the same scenario as the one above, except that the company issued $45,000 worth of checks to vendors, and only $30,000 of checks were presented to the bank for clearance. The company, as before, had $40,000 of cash in the bank account.

When the company issued checks, it debited Accounts Payable and credited Cash for $45,000. As the checks for $30,000 were cleared, the bank withdrew money from the company's account, and at the end of December the bank account's balance was $10,000 ($40,000 – $30,000). At the same time, the company's records show a negative balance of $5,000, i.e. the initial balance of $40,000 less checks totaling $45,000. Even though not all checks cleared the balance, the company's records still show a negative balance of $5,000.

The $5,000 in this case is only on the company's books because the bank shows $10,000 remaining in the account. Compare this with the scenario above where all checks were cleared by the bank (totaling $45,000), and both the bank and the company showed a negative cash balance of $5,000 in the bank account.

2. Presentation of negative cash balances on balance sheet

In both scenarios, the company had a negative cash of $5,000. In both cases, the negative cash balance should be presented in the liabilities section of the balance sheet, not in the assets section.  The reason is because the negative cash balance represents the company’s liability to a third party.

In the first scenario (a), the liability is to the bank because the bank extended a credit (short-term loan) to the company in the form of an overdraft.

In the second scenario (b), the company would normally reclassify the excess of checks issued over the cash in the bank account back to the accounts payable (by debiting Cash and crediting Accounts Payable).  Therefore, the negative cash balance would be presented in the liabilities section as part of accounts payable.  Note, however, that sometimes a company may have multiple accounts with the same bank.  If a legal right of offset exists, then the cash in other accounts can be used to “cover” the negative cash balance, and thus, no reclassification from cash to accounts payable will be needed.

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