Businesses, no matter how small or big, need to borrow money from time to time to finance daily operations. Since it is very common for businesses to acquire loans for meeting short term and long term expenditures, there are numerous types of financial tools, such as loans, readily available.
Two of the most popular forms of loans are cash credit and overdraft.
In this article, we will understand what cash credit and overdraft are and the difference between cash credit and overdraft based on different parameters.
What is Cash Credit?
Cash credit refers to a variant of short term loans that financial institutions offer to small and medium businesses to cover and fulfil financial obligations.
Business-owners can use this method of financing without having credit balance in their account. Cash credit is a drawing account which functions similarly to a current account on which an overdraft facility is provided.
The lending institution charges interest on the amount withdrawn by the customer and not the entire cash credit loan amount. This is one of the main reasons businesses opt for this method of financing over other options.
Characteristics of Cash Credit
Here are some of the most prominent characteristics of cash credit loans:
- Cash credit is a borrowing option without any credit balance. However, it features a loan limit which is decided by the lending organisation.
- Since the sanctioned amount is repayable on demand, the lending institution has the authority to demand the borrowed amount back from the customer at any instance.
- The loan limit depends up to an extent on the value of the securities pledged as collateral.
Forms of Cash Credit
Cash credit loans come in numerous forms. Here is a look at some of the most popular ones:
1. Cash Credit Against Hypothecation of Stock
The majority of banks and other financial institutions offer this form of cash credit facility against raw materials, finished goods, and WIPs’ security.
2. Cash Credit Against Hypothecation of Book Debts
This form of cash credit is generally offered by financial institutions against book debts. “Book debts” also include debt entries made in the account books which have happened as a result of the sales made.
3. Packing Credit
Packing credit is another variant of cash credit that banks offer to exporters for purchasing raw materials from local stores and markets and ensuring that the goods or products are ready for export. The packing credit facility is generally extended to customers in domestic currency.
What is Overdraft?
An overdraft facility refers to short-term credit that financial institutions like banks offer current account holders. In this type of loan facility, holders can easily withdraw money over the actual amount of cash available in their current account up to a set limit decided by the bank or lending institution.
Overdraft facility is offered to individuals based on their credit history. The customer, irrespective of whether it is an individual or a business, can withdraw funds as per their requirements.
The repayment of the borrowed amount must be made through deposits in the current account. Overdraft facility is also granted against security of self-liquidating investments such as shares and debentures, term deposits, LIC policies, UTI units, etc.
Types of Overdraft
Two of the most popular types of overdrafts are clean overdrafts and secured overdrafts. Here is a detailed look at both:
1. Clean Overdraft
In a clean overdraft, the overdraft facility is extended in a current account without any tangible security.
2. Secured Overdraft
A secured overdraft refers to a form of overdraft where the facility is extended against self-liquidating securities.
Characteristics of Overdraft
Here are some of the most prominent characteristics of overdrafts:
- It is a running loan account, so it facilitates any account holder to perform debits and credits without hassle.
- The rules of an overdraft account and a current bank account are similar.
- The debit of interest happens daily. However, the bank or lending institution debits the same interest amount to the account every month. However, when it comes to temporary overdrafts, the lending institution debits the interest amount at the earliest of the two, i.e., as per its adjustment date or at the month’s end.
- Banks offer the overdraft facility to customers only when they provide a written request asking for the same. Moreover, there are numerous instances when banks require customers to sign a promissory note. This leads to the drawing up of an express contract.
Similarities between Cash Credit (CC) and Overdraft (OD)
Both cash credit and overdraft share a resemblance in numerous aspects. Here are two of the most important similarities between them:
- Both are deemed financial instruments offered to individuals or businesses against the security of business-related assets and/or current inventory.
- The rate of interest for both cash credit and overdraft is charged on the amount used by the borrower and not on the entire loan amount.
- Both cash credit and overdrafts are offered by numerous online and offline financial institutions. Most people prefer online financial platforms over offline ones since they offer a more convenient and hassle-free experience. A great online platform for acquiring cash credit, overdraft, or numerous other types of loans is Yubi Loans. It is India’s leading digitised corporate lending platform that features over 750 reputed lenders. Trusted by 3000+ borrowers, the platform offers 5x quicker transaction time than other lenders. Individuals looking to acquire funds for fulfilling personal or business-related financial obligations can choose Yubi Loans to acquire funds instantly without experiencing any hassle.
|Meaning||Cash credit refers to accounts through which financial institutions offer short term loans to small businesses that require instant capital.||Overdraft is a short-term loan facility wherein customers can withdraw surplus money than their account’s actual balance. The overdraft facility is generally associated with a current account.|
|Arrangement||Cash credit is deemed a revolving credit arrangement.||The overdraft facility is not a type of revolving credit arrangement.|
|Associated With||Cash credit account||Current account or a secured loan against investment.|
|Availability of Facility||Only business owners can opt for cash credit.||Both regular individuals and businessmen can opt for overdraft.|
|Security||Requires inventory’s hypothecation and the availing loan’s receivables.||An unsecured OD on a current account is dependent upon the individual’s average balance, creditworthiness, etc.
A secured OD can be availed against fixed deposits or LICs.
|Nature of Limit||Flexible||Fixed
|Maximum Limit||Approximately 50-60% of the inventory and receivables’ value.||In case of an unsecured OD, it depends on the bank’s discretion.
When it comes to secured OD, the limit depends on the security’s term.
|Term||Up to 12 months||In the case of an unsecured OD, the term is usually around 7 days to 1 month.
A secured OD’s term depends on the security’s term.
|Purpose||The loan amount can be used for business purposes only.||It can be availed for both personal and business-related financial needs.|
|Change in Withdrawal Limit||It is altered instantly whenever the inventory or receivables’ value changes.||It does not change easily.|
|Interest Rate||Lower rate of interest.||Unsecured ODs feature a higher rate of interest, whereas a secured OD features a lower interest rate.|
Difference Between Cash Credit and Overdraft
|Interest Rates||Lower rate of interest as opposed to overdraft.||Comparatively higher interest rates.
|Security/Collateral||Lending institutions offer cash credit loans upon stocks and inventory’s hypothecation.||The overdraft facility is offered to individuals based on their relationship with the lending institution, credit history and score, investments, etc.
|Usage||The amount acquired can only be used for fulfilling business-related obligations.||Individuals can use the loan amount to cover business and personal expenses.
|Tenure||12 months||Decided based on the individual’s security deposits and financial statements.
|Sanction Amount||The amount is decided based on the volume of the individual’s stock and inventory.||The amount is decided based on security depositions & financial statements.
|Who are Eligible||Business traders, retailers, LLPs, distributors, manufacturing firms, distributors, etc.||Only current account holders of respective banks,|
Points to Remember
Every individual who wishes to opt for cash credit or the overdraft facility to fulfil personal or business-related needs should be familiar with the following terms and points:
Processing Fee: Every lending institution charges a certain amount of money for processing a cash credit, or overdraft application called the “processing fee“. Different banks charge different amounts of processing fee when it comes to cash credit and
Loan Amount Utilisation: When it comes to cash credit, the limit is specified against the hypothecation of stock. However, there are multiple banks which levy an additional amount on the loan’s un-utilised amount after a specific period.
Foreclosure Charge: There are numerous lenders who levy foreclosure charges if and when the borrowing individual decides to close the account. Moreover, they also charge a specific percentage of the lent amount for closing the debt account.
What is the general tenure for a personal overdraft loan?
The general tenure for a personal overdraft ranges between 1 and 5 years. The general tenure varies from lender to lender.
When do banks generally generate interest rates?
Banks generally generate interest rates at the end of every month, i.e., on the 3oth or 31st day of the month.
Why is the first instalment of an overdraft loan always high?
The first instalment of the loan comprises B, PF, insurance, etc. Thus, its amount is usually higher than other instalments.
Whom should I approach to express concerns or register complaints?
Customers having queries regarding the loan or any of its aspects can contact the lending institution’s toll-free number or visit their nearest branch to clarify any doubts in person.
Should I go for a cash credit or overdraft facility if I have the money?
Opting for a loan is always a good idea for individuals looking for a secure method of financing. However, they should take the final decision after consulting their financial advisor.
What is the security in the case of CC and OD Facility?
Both cash credit and overdraft are offered to individuals against the security of business assets or current inventory.
How can I access funds once my overdraft is approved?
Once the overdraft facility is availed by an individual, the money is not disbursed immediately to them. It functions similar to an approved loan. As and when needed, they can withdraw money from the overdraft account to fulfil financial obligations.
When do I need to repay the overdraft facility?
In most cases, the repayment period of an overdraft facility is 12 months.