One of the many decisions you have to make when starting a business is what type of financing to use. There are a few different types of financing available, and it can be challenging to decide which is right for your business. This blog post will discuss the difference between cash credit and overdraft and help you decide which option is best.
Before going ahead to find out and understand the differences between cash credit and overdraft, let us quickly understand the meaning of both these terminologies one by one.
Table of Contents
Cash Credit (CC)
Banks provide cash Credit loans to businesses, companies, and financial institutions to look after their working capital requirements. The borrower can opt for the loan facility without a credit balance and up to the specified limits the lending bank keeps. Borrowing limits vary from bank to bank.
Cash Credit loans can be helpful for smaller businesses that often struggle financially in the beginning and need something extra like working capital or emergency funding.
Importance of Cash Credit
- Cash credits are a great way to get your business up and running without depending on long-term financing.
- These short-term loans can fund any necessary cash requirements. Such as purchasing current assets or settling accounts payable immediately, so you don’t run into trouble later!
- Cash credit is a loan, and banks demand collateral to approve it. The interest charged on daily closing balances rather than an individual’s borrowing limit means that users only have access to the cash they’ve spent, making repayment quick for those who need funds quickly but don’t want long-term debt from regular loans or cards;
- However, there are still risks associated with this type of loan arrangement. Since not all companies may withstand any financial shock if something goes wrong, still, an economic tragedy could lead them into bankruptcy court, where their assets would become available for sale.
Salient Feature of Cash Credit
- The cash credit allows you to draw money from your Line of Credit whenever necessary, as long as the bank is satisfied with the hypothecated property and its valuation.
- The more years a business has been operating and having funds available for borrowing. They’ll have an easier time getting approval as compared to someone who just started up recently or had no previous track record whatsoever in this regard. It also helps determine how much interest will cost per year based on those numbers alone.
- Overdrafts can be available from an existing account, but cash credits require commitment charges.
- A creditworthy business will have good financial statements to quickly receive loans and purchase inventory. At the same time, the company shall pay off what they owe with competitive interest rates against other banks’ offers. Also, an excellent financial history gives confidence to the bank. However, banks have to properly check the documents related to the property, which will work as collateral against the sanctioned or applied loan amount.
- The cash credit allows you to draw money from your Line of Credit whenever necessary, as long as the bank is satisfied with the hypothecated property and its valuation.
- The more years a business has been operating and having funds available for borrowing. They’ll have an easier time getting approval as compared to someone who just started up recently or had no previous track record whatsoever in this regard. It also helps determine how much interest will cost per year based on those numbers alone.
- Overdrafts can be available from an existing account, but cash credits require commitment charges.
- A creditworthy business will have good financial statements to quickly receive loans and purchase inventory. At the same time, the company shall pay off what they owe with competitive interest rates against other banks’ offers. Also, an excellent financial history gives confidence to the bank. However, banks have to properly check the documents related to the property, which will work as collateral against the sanctioned or applied loan amount.
Overdraft
The overdraft is an agreement with the bank that allows you to spend more money than you have in your account. For example-
You want to purchase machinery worth Rs. 1 Lakh, and in your current/savings account, you have only Rs. 60 Thousand at the moment, In this case, you can request the bank for a credit extension. Bank provides overdraft facilities even if you have zero balance in your account, depending on your financial history and bank relationship.
An overdraft can be a useful option if you know that you’ll be short on cash at the end of the month. Still, it’s important to remember that fees are usually associated with this type of arrangement.
The overdraft system allows people to continue making withdrawals from their accounts, even below zero. Overdraft fees and interest rates vary by bank.
Also Read: 10 Best Crowdfunding Platforms in India
Importance of Overdraft
- Overdrafts are one of the most convenient ways to get money when you need it. They allow businesses and individuals alike to access funds without having to worry about credit checks or loan applications, which can be time-consuming and stressful in itself.
- The overdraft allows a person short on cash to make purchases now instead of waiting until later when they have more funds available.
- It also gives borrowers some flexibility if something unexpected happens. For example, an emergency expense comes up, or there’s a loss of income for any reason, then this loan can help out during those times as well!
- The overdraft granted to any account holder older than 18 and younger than 65 will depend significantly on their credit history, score, or the value of that particular checking account. The bank decides how much you can borrow and for what duration. You must have an account with them to apply for OD.
- The bank decides the upper limit depending upon the relationship between the lender and the borrower.
Salient Feature of Overdrafts
- Overdrafts are one type of credit that allows people to spend more money than they have in their accounts.
- In an overdraft, the loan interest is charged only on the amount utilized, unlike regular bank loans where the bank charges interest on the entire amount.
- Overdraft carries higher interest rates.
Now, Let’s understand the difference between Cash Credit and Overdraft in detail:
Difference Between Cash Credit and Overdraft
- Cash Credit Loan carries a lower interest rate as compared to overdraft. On the other hand, an overdraft loan is available at higher interest rates against cash credit.
- Cash credit loan is available on collateral and hypothecation of assets & inventory, and it’s a secured loan. Overdraft is an unsecured loan, and Banks can provide overdraft credit facilities based on the company’s financial journey. Bank also considers borrowers relationship with the bank and other investments like LIC & Fixed deposits.
- Cash Credit is provided only for instant cash requirements or to purchase current assets. An individual can avail overdraft facility for the fulfilment of any business-related requirements.
- The loan amount for cash credit shall be 60% of the value of the hypothecated assets with the Lender bank. The loan amount for overdraft depends on the current financial position, investments, and relation with the borrower’s lender.
- The credit borrower needs to open a new account with the lending bank for a cash credit loan. Bank gives an overdraft loan to the existing bank account of the applicant.
- The minimum duration for a cash credit loan is one year. Overdraft loans can be provided for a month, quarter, or a maximum of 1 year.
- Traders, Manufacturers, Retailers, Distributors, Companies, Partnership firms, Sole proprietors can apply for a Cash credit loan facility. An individual who has an account in the respective bank can apply for an overdraft loan facility.
- Banks can give cash credit loans to the applicant based on the market situation and business performance. And banks provide overdraft loans to the applicant based on their relationship with the customer.
Conclusion
One of the most important financial decisions you’ll have to make is whether or not your business needs a loan. There are many different types of loans, and each one has its pros and cons.
For example, a cash credit can be used in emergencies when an unexpected expense arises.
An overdraft would allow you to spend more than what’s in your bank account without incurring any fees as long as there is still some amount available on that line of credit, which could save you from costly late payment penalties.
An overdraft is more expensive in terms of interest rates. Still, it does offer borrowers some flexibility if something unexpected happens. So, we can see a few key differences between a cash credit loan and an overdraft.
On the other hand, a cash credit loan is cheaper in interest rates and is available against collateral. It’s a good option for businesses with a steady cash flow for short-term needs. Thanks for reading!
