When businesses or individuals need quick access to funds to manage short-term expenses, they often look for flexible financing options. Two common solutions offered by banks are cash credit and overdraft facilities. Both allow borrowers to withdraw money beyond their account balance, but each has its unique features and suits different needs.
Understanding what is cash credit facility and what is overdraft in bank can help you make a smarter financial decision. This blog will explain both concepts, highlight their differences, and guide you on which option might be better for your situation
What is Cash Credit?
A cash credit facility is a type of short-term loan primarily designed to help businesses manage their working capital requirements. When a bank provides a cash credit, it sanctions a credit limit against a business’s current assets, such as inventory, receivables, or fixed deposits.
The borrower can withdraw money up to the approved limit as needed, and interest is charged only on the amount actually used, not the entire limit. This flexibility helps businesses bridge gaps between their cash inflows and outflows, ensuring smooth operations.
The benefits of cash credit loan include quick access to funds and interest charged only on the amount utilised. This can make it more cost-effective than a regular loan if usage is low or fluctuating, and it also allows the facility to be used repeatedly during the tenure without reapplying.Typically, a cash credit is reviewed annually and renewed based on the borrower’s creditworthiness.
In short, a cash credit is an efficient way for businesses to maintain liquidity without taking on a full loan amount upfront.
What is Overdraft?
An overdraft facility allows an account holder to withdraw more money than what is currently available in their account, up to a sanctioned limit. This acts as a financial buffer to cover unexpected or short-term expenses by temporarily using the bank’s funds.
Banks can offer overdrafts against a current account or a savings account, depending on their policy and the customer’s profile. For businesses, current account overdrafts are more common, while for individuals, overdrafts are often linked to salary accounts or fixed deposits.
Interest is charged only on the amount actually overdrawn and is usually calculated on a daily outstanding basis. Secured overdrafts, such as those backed by fixed deposits, typically carry lower interest rates, while unsecured overdrafts have higher rates due to the increased risk.
The overdraft limit is often linked to the account’s average balance, credit history, and collateral, if any. Repayment is flexible, as the overdrawn amount is replenished when the account holder deposits money.
Key Differences Between Cash Credit and Overdraft
Although cash credit and overdraft appear similar, there are important differences to keep in mind:
- Purpose and Usage: Cash credit is primarily designed for businesses to meet their working capital needs, such as financing stock, raw materials, or receivables. Overdraft, on the other hand, can be used by both businesses and individuals. It serves more as a short-term liquidity buffer, linked directly to a current or savings account.
- Collateral Requirements: Cash credit facilities are typically secured against current assets like inventory and receivables, with banks closely monitoring these assets. Overdrafts may be secured or unsecured, depending on the customer profile and the bank’s policy. Secured overdrafts are often backed by fixed deposits, property, or other assets, while unsecured overdrafts rely on the borrower’s creditworthiness.
- Interest Calculation: Both charge interest only on the amount used, but cash credit interest rates tend to be slightly lower since the facility is often secured. Overdraft interest rates might be higher, reflecting the unsecured or short-term nature of the credit.
- Documentation and Approval: Cash credit generally involves a more detailed approval process with verification of stock and receivables. Overdraft approval is faster and requires less documentation, especially for smaller limits.
- Renewal and Tenure: Cash credit limits are reviewed and renewed yearly, with businesses expected to manage their working capital within this period. Overdraft limits can be more flexible and short-term, sometimes granted for months or even weeks.
Which One is Better for You?
Choosing between cash credit and overdraft depends largely on your financial needs, the purpose of the funds, and your business or personal profile.
- When to Opt for Cash Credit:
If you run a business that needs regular, predictable working capital to purchase raw materials, manage inventory, or meet operational expenses, a cash credit facility is suitable. It offers a revolving line of credit backed by your business assets and helps maintain cash flow without the burden of a fixed loan amount. The benefits of cash credit loan in such cases include cost efficiency, ease of access, and better terms. - When to Choose Overdraft:
If you need funds occasionally to cover short-term cash crunches or unexpected expenses, an overdraft facility is often more convenient. It is useful when withdrawals beyond your balance are irregular or less predictable. Overdrafts are also helpful for individuals who want a safety net in their bank account to avoid bounced checks or penalties.
Consider the following before deciding:
- How much money do you need, and for how long?
- Do you have assets or receivables to offer as collateral?
- Is your requirement recurring or one-time?
- What are the costs involved, including interest rates and fees?
- How quickly do you need the funds?
A simple way to compare is through a checklist or table that weighs your specific needs against each facility’s features.
Conclusion
Understanding what is cash credit facility and what is overdraft in bank is essential before opting for either. Both have their strengths and are designed for different types of financial needs.
A cash credit is generally better for businesses needing ongoing access to working capital, while an overdraft suits short-term, occasional funding requirements. Carefully evaluate your financial situation, repayment capacity, and the costs involved before making a decision.
Consulting your bank or a financial advisor can provide personalized guidance, helping you choose the option that aligns best with your cash flow and growth plans.
