Average Outstanding Balance

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The average outstanding balance, or AOB, is one of the fundamental ideas in finance. It represents the total amount of debt that has not been repaid over a given period of time, often one month. 

Any loan type, including term loans, installment loans, revolving loans, and credit cards, may be included in the average outstanding balance calculation.

Both lenders and borrowers should pay attention to the average outstanding balance since it has an impact on the interest rates that are charged or paid, the risk and profitability of the loan portfolio, and the borrower's credit score.

How to Calculate the Average Outstanding Balance

Depending on the type and frequency of loan payments, there are various approaches to determine the average outstanding balance. For a term loan with set monthly payments, for instance, the beginning and ending loan sums can be added, and then the average outstanding balance is divided by two. 

In contrast, you may determine the average outstanding balance for a revolving loan, like a credit card, by adding up the daily balances and dividing by the number of days in the billing cycle. With a credit card, the balance fluctuates every day depending on the purchases and payments the cardholder makes. 

In order to calculate interest on outstanding accounts, credit card companies frequently employ a technique known as the average daily balance approach.

The formula for calculating the average outstanding balance using the average daily balance method is:


Average Outstanding Balance = (Sum of Daily Balances) / (Number of Days in Billing Cycle)


For example, suppose a credit card has a billing cycle of 30 days, and the cardholder makes the following transactions:


Day 1: Beginning balance = $0
Day 5: Purchase = $500
Day 10: Payment = $200
Day 15: Purchase = $300
Day 20: Payment = $100
Day 25: Purchase = $200
Day 30: Ending balance = $700


The sum of daily balances can be calculated as follows:


Sum of Daily Balances = ($0 x 4) + ($500 x 5) + ($300 x 5) + ($600 x 5) + ($500 x 5) + ($700 x 6) = $17,000


Therefore, the average outstanding balance is:


Average Outstanding Balance = $17,000 / 30 = $566.67

Why is the Average Outstanding Balance Important?

The average outstanding balance is important for several reasons. First, it determines the amount of interest that is charged or paid on a loan. For example, if a credit card has an annual percentage rate (APR) of 18%, and the average outstanding balance is $566.67, then the interest charge for one month is:


Interest Charge = (APR / 12) x Average Outstanding Balance
Interest Charge = (0.18 / 12) x $566.67
Interest Charge = $8.50

Second, it displays the profitability and risk of a lender's loan portfolio. A lender must evaluate the performance and quality of all of the loans it has, which are often many and made to different borrowers. A lender's ability to collect loans and earn interest revenue can be gauged by looking at the average outstanding balance. 

A high average outstanding balance on a lender's loans could indicate that it is having problems recovering its principal from borrowers or that it is lending an excessive amount of money to high-risk clients who might stop making payments. This can result in monetary losses and decreased lender profitability.

Third, it has an impact on a borrower's credit rating. Based on a borrower's credit history and conduct, a credit score is a numerical indication of how creditworthy they are. Credit bureaus employ a number of characteristics, including payment history, duration of credit history, types of credit used, and amount owing, to determine a credit score. 

The average balance on credit cards and other revolving loans, as well as the proportion of outstanding balance to credit limit (also known as credit utilization ratio), are included in the amount owing factor. A borrower's credit score can be lowered by a high average outstanding balance or a high credit usage ratio, which shows that they are utilizing too much of their available credit and might have trouble repaying their debt.

How to Manage the Average Outstanding Balance

For borrowers who want to reduce their interest charges, improve their credit score, and avoid financial stress, it is advisable to manage their average outstanding balance carefully. Some tips to do so are:

• Make a larger monthly payment on credit cards and other revolving loans than the required minimum. This will accelerate principal reduction and cut interest payments.
• Prioritize paying off high-interest debt. This will result in interest cost reductions and increase available cash flow for other costs or savings.
• Avoid using credit cards for irrational purchases or cash advances. This will stop the existing debt total from growing and the interest rates from rising.
• Keep track of the credit card payment due date and billing cycle. This will make it easier to organize payments and prevent late fees and penalties.
• Check the average debt due and the interest rates on the credit card statements. This will make it easier to keep track of the development and, if necessary, modify the payment plan.
• Ask the credit card company to reduce the interest rate or increase the credit limit. As a result, the credit score will rise and the interest rates and credit utilization ratio will decline.
  

Conclusion

A financial concept known as the average outstanding balance calculates the total amount of debt that has not been repaid over a given period of time, often one month. Any loan kind, including term loans, installment loans, revolving loans, and credit cards, are all eligible for it. 

Both lenders and borrowers should pay attention to the average outstanding balance since it has an impact on the interest rates that are charged or paid, the risk and profitability of the loan portfolio, and the borrower's credit score. Depending on the type and frequency of loan payments, there are various approaches to determine the average outstanding sum. 

The average daily balance approach is typically used for revolving loans like credit cards. It is advised for borrowers who want to lower their interest costs, raise their credit score, and prevent financial stress to carefully manage their average outstanding balance by adhering to some guidelines like paying more than the minimum payment, paying off high-interest debt first, avoiding pointless purchases or cash advances, keeping track of the billing cycle and the due date, reviewing the credit card statements, and asking for a lower interest rate or a high credit limit.