Cash Credit is a short-term loan offered by banks for a maximum period of 12 months on renewal basis to the entrepreneurial entities like companies, sole proprietorship, partnership and LLP businesses to meet their regular business-related working capital requirements. Whereas a bank overdraft facility is credit funding offered by banks to individuals and various business entities to withdraw money from the banks in which they have accounts, even if their account balance is low, zero, or below. Generally, Cash Credit and bank overdraft are mistakenly considered as similar credit facilities and to get rid-off such dilemmas, being an emerging entrepreneur, one must know what are the differences between cash credit and bank overdraft account for the perfect selection as per the need of the business.
What is Cash Credit?
Cash Credit is a short-term working capital loan approved by banks for businesses, financial institutions and companies to meet their working capital requirements.
The borrowing company can take money, even without a credit balance, up to whatever borrowing limit exists based on the drawing power as set by the lender bank on the calculation of the net value of stocks and debtors subject to the maximum of sanctioned limit which in general is 20% of the yearly sales figure.
The interest is charged only for that period for which the amount withdrawn for the business purpose and not on the whole sanctioned limit or unutilised drawing power.
Cash credits are called working capital loans as they fund the instant cash requirements of the organizations in order to meet the daily expenses of the businesses like procurement of raw materials, payment of labour wages and staff salaries, debt consolidation and creditors payment etc.
What is bank overdraft?
A bank overdraft account is a credit facility that allows money to be taken out of a current account even if the balance falls below zero. It is a form of monetary limit extension provided by banks, and the money is referred to as overdrawn.
Each customer is given an allowed overdraft limit based on their connection with the bank. The consumer has the option of withdrawing money up to the specified amount. Banks only charge interest on the portion of the overall sanctioned limit that has been used.
What are the differences between Cash Credit and bank Overdrafts?
Cash credit is a type of company loan that is used for a brief period of time. It is intended for business owners that want immediate working funds.
A bank overdraft account, on the other hand, is that type financial product which allows the borrower to withdraw money from the current account even if there is no money in it to meet both business expenses as well as other expenses not related to the business.
Although both are referred to as credit facilities that the lender banks provide to borrowers but cash credit and bank overdraft account are different from each other on various aspects of their features which are stated as under:
Interest rates:
- The interest rate on cash credit is lower than that of bank overdraft account.
- The interest rate on bank overdrafts is slightly higher than that on cash credit.
Calculation of interest:
- Calculated based on the entire amount that is withdrawn.
- Calculated based on only the amount that is availed.
Security or collateral:
- Cash credit loan is offered upon hypothecation of inventory and stocks.
- Bank overdraft account withdrawn limit amount is decided based on the relationship with the bank, credit history, and investments such as fixed deposits, insurance policies, etc.
Duration of loan:
- The loan duration is generally 1 year on renewal basis.
- The loan duration can vary and it can be monthly, quarterly, half yearly or yearly.
Limit of withdrawal:
- Can be changed based on the value or quantity of the inventories and book debts in cash credit
- Under bank overdraft account the withdrawal limit cannot be changed. The current balance may influence the current account.
Bank Account:
- Cash credit needs a separate bank account from where it is required to be operated.
- Bank Overdraft account can be availed from an existing current account. No new or separate account is required for its operation.
Maximum Amount:
- The maximum drawing power which can be is 60% of the value of the net inventories and net book debts subject to the maximum sanction limit of 20% of yearly sales or turnover.
- The lender decides based on the financial statements and the relationship with the lender bank but in general a withdrawn limit of 20% of the total turnover is provided if it is a secured bank overdraft account.
End use and purpose:
- The end use and the purpose of cash credit is to provide fund for buying raw materials, take care of receivables and maintain stocks and only to meet all other business-related expenses.
- Bank overdraft account can be availed for any general purposes including business-related expenses.
Who can be an applicant:
- Individuals, traders, retailers, manufacturers, companies, partnerships, distributors, LLPS, sole proprietorships, etc. are eligible to apply for cash credit facility.
- Only account holders of the respective banks are eligible for a bank overdraft facility.
Charges:
- There are no charges for the processing of cash credit facility.
- In case of bank overdraft charges may be applied by the lender bank as per the policies.
Conclusion:
Both cash credit loans and bank overdraft account facilities are useful financial tools that help small businesses meet their working capital requirements. However, before making a decision on whether to take a CC or an OD, consider the interest rate, processing fees, and other features of both products.
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