What is a Compensating Balance?

How Does a Compensating Balance Work?

• The required balance is typically a percentage of the loan or credit line.
• It may be held in a non-interest-bearing account, meaning the organization cannot earn interest on those funds.
• The balance effectively reduces the total available cash, as the organization cannot freely use those funds for other purposes.

Is a Compensating Balance a Current Asset?

Organizations must carefully review their banking agreements to determine the appropriate classification based on access to funds and reporting requirements.

A compensating balance held in a demand deposit account is typically classified as a current asset, as these funds are readily accessible and used for day-to-day operations.

However, if the balance is restricted for a longer period due to a banking agreement, such as being tied to a loan covenant or collateral requirement, it may be classified as a non-current asset on the balance sheet.

To ensure proper classification, organizations should carefully review their banking agreements, considering fund accessibility, reporting requirements, and financial statement implications.

What’s important here?

A compensating balance is a required minimum deposit that organizations must maintain as part of a banking or loan agreement. While it can lead to better loan terms or lower banking fees, it also restricts access to cash that could be used elsewhere. Organizations should carefully consider whether maintaining a compensating balance aligns with their financial strategy and liquidity needs.