Cash credit and overdraft facilities are types of working capital loans provided to businesses to address their short-term obligations.
Difference Between Cash Credit and Overdraft Facility
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Economists agree that credit has a multiplier effect in an economy. Similarly, the availability of credit to businesses often provides conducive factors for the enterprise to grow. However, a business owner might get confused with the various types of credit funding offered by financial institutions.
Apart from the conventional business loan, there exists two credit products in the market, which often seem similar but are quite different- cash credit and overdraft facility. Let us understand the difference between cash credit and overdraft facility to determine which one is suitable for your business requirements.
What is Cash Credit?
Cash Credit is a short-term loan provided to businesses against collateral security for their working capital requirements. It is usually issued with a maximum credit limit valid for a period of one year.
Usually, cash credit loans require current assets like inventory or stock as collateral. While sanctioning a credit limit, banks usually take into consideration the turnover of the business, its unpaid invoices, finished goods, raw materials, etc.
In Cash Credit loans, interest is charged on the amount utilised and not the loan amount sanctioned amount. However, some banks may levy charges on the unutilised amount and foreclosure charges in case of closure of the loan amount.
To avail cash credit, businesses usually have to open a cash credit account with a financial institution with commitment charges. At times, banks may provide cash credit loans to individuals against collaterals like fixed deposits.
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What is an Overdraft Facility?
Similar to Cash Credit, an Overdraft Facility entails a borrowing limit provided to businesses in their overdraft account to help them address their cash flow issues and short term obligations.
Account holders can withdraw money from their overdraft account to make payments for operational expenses. The account holders pay interest on the amount utilised by them, and not the limit sanctioned.
In the case of a Drop-line Overdraft (DOD), the limit sanctioned by the financial institution is subject to monthly reduction.
It can either be secured or unsecured. In case of a secured overdraft, the collateral can either be a property, shares, fixed deposits, security deposits etc.
Difference Between Cash Credit and Overdraft
| Cash Credit | Overdraft |
| It is usually provided to address cash flow inefficiencies. | It is usually provided for working capital requirements. |
| It is usually provided for up to a year. | It can either be provided for up to a year in case of OD, or more than a year in case of Drop-line Overdrafts. |
| It is provided based on the credit history, financial statements, value of the collateral (which may include the inventory or the stock of the business), etc. | It is usually provided based on the credit history, a good relationship with the lender, credit score, etc. |
| Interest rates for Cash Credit are lower than those of Overdraft. | An Overdraft usually has a lower interest rate than Cash Credit. |
| The borrowing limit does not decrease in case of Cash Credit. | Monthly reduction of the borrowing limit in case of Drop-line Overdraft. |
| Cash credit is usually provided for business purposes. | Overdrafts can be used for general purposes, including business purposes. |
| A new account has to be opened with a financial institution to avail cash credit. | Businesses can apply for an overdraft in their existing account. |
| Cash Credit can be repaid daily, monthly, quarterly, or on a half-yearly basis. | Overdraft limit utilized can be repaid as and when the borrower has the capacity to pay. |
Conclusion
An Overdraft limit and Cash Credit are often very similar in the nature of financial assistance they provide to businesses. However, while availing a business loan for working capital, you should be aware about the difference between cash credit and overdraft to determine which one is suitable.
To recapitulate, while cash credits are short-term loans often given on an annual basis in a new loan account, overdraft facilities can be provided in an existing bank account.
Similarly, while a dropline overdraft facility has a limit that reduces monthly, the limit sanctioned for a cash credit remains constant throughout the tenure. However, none of the financial instruments can be used for long-term funding, and are suitable for small businesses that have inconsistent cash flows requiring additional money for various business needs.
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FAQs
What is the difference between CC and WCDL?
While both Working Capital Demand Loan (WCDL) and Cash Credit (CC) are a type of short term loan offered by banks and other financial institutions, they both differ in the mode of repayment.
While WCDL is a demand loan with a fixed repayment schedule, CC is like an overdraft with the option to repay the amount as per the convenience of the business.
What is the difference between OD and OCC?
Open Cash Credit (OCC) is a credit limit provided to existing account holders of a bank against the security of accounts receivable/stock/inventory of the business. The sanctioned limit under a cash credit is usually valid for a year. In contrast, overdraft facilities may be secured or unsecured and the sanctioned limit may decrease each month in the cash of a dropline overdraft.
What is the difference between a cash credit and a loan?
A business or personal loan is sanctioned by a bank or NBFC with a fixed repayment tenure and interest charged on the total sanctioned amount. On the other hand, cash credit (CC) is a credit limit allotted to an account holder with interest levied only on the amount utilised from the loan account. In addition, the processing fees charged by banks may also differ for both types of loans.
Is cash credit and working capital loan the same?
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