As a business owner, you must be aware that capital is the most crucial factor in ensuring that your company runs smoothly. Small and medium businesses both require capital from time to time to keep their operations running smoothly.
You must always have enough funds to meet your operational expenses to run a successful business. Financial institutions now offer a variety of financing options to help you with your funding needs in a cash crunch. Cash credit loans and overdraft facilities are two of the most commonly used loan products among these options.
But at the same time, there is a difference between overdraft and cash credit. Most people mistakenly believe that both of these things are identical, but they are not. We will go over cash credit and overdraft meaning and learn more about Cash Credit vs Overdraft. Towards the end of this article, we will also highlight the key difference between od and cc.
Table of Contents
Cash Credit Meaning: What Is Cash Credit?
Cash Credit (CC) is a short-term loan designed to assist self-employed professionals and business owners with their working capital needs.
How Does Cash Credit Work?
Cash credit is a type of working capital loan with a 12-month repayment period. Businesses can withdraw funds from their account over their account balance as often as they want, up to a predetermined borrowing limit. The cash credit limit is renewed when the loan term is completed successfully. Under this financing arrangement, the interest is only charged on the withdrawal amount, not on the entire borrowing limit.
The funds can be used for various purposes, including purchasing raw materials, paying wages, and paying utility bills.
Overdraft Meaning: What Is Overdraft?
You are probably wondering what exactly an overdraft is. Some people confuse the terms cash credit and overdraft, but there is a significant difference between cash credit and overdraft.
An overdraft is a line of credit provided by a bank to a select group of customers. Current account holders can withdraw money from their bank accounts using the OD facility, even if their balance is low or even zero.
How Does Overdraft Work?
- When you apply for an overdraft or have a pre-approved overdraft limit, you have the option to overdraw funds from your account up to a pre-determined limit after approval. When you use your overdraft limit, you are increasing the outstanding balance on your account.
- As soon as you deposit funds into your account, the outstanding balance decreases.
- You can repay the lender in full or in part under this financing arrangement. You can overdraw the funds until your overdraft limit is exhausted after you repay the lender.
Cash Credit VS Overdraft: Difference Between Cash Credit And Overdraft
Let’s look at the key differences between cash credit and an overdraft before you make a decision.
| Parameter | Cash Credit | Overdraft |
| Definition | Cash Credit (CC) is a type of short-term loan that companies, businesses, and financial institutions can use to meet their working capital needs. | An overdraft is a type of credit facility provided by banks to individuals and businesses to withdraw money from their accounts even if their balance is low, zero, or negative. |
| Purpose | Part of business finance that allows you to meet short-term cash needs like working capital, raw material purchases, and so on | This is a long-term business loan that allows you to grow your business while keeping it afloat. |
| Rate of Interest | The interest rates on cash credit are lower than those on overdrafts. | Overdraft interest rates are slightly higher than cash credit rates. |
| Need Of Account | To receive the cash credit loan amount, you must open a new account. | You can use your existing account to obtain an overdraft. |
| Calculation Of Interest | The maximum amount is calculated as a percentage of sales and stock along with financial statements. For example, a bank allowed cash credit up to 80% of stock plus 20% of sales. | The maximum amount that can be borrowed is determined primarily by financial statements and security. |
| Duration Of Loan | A one-year repayment period is typical for cash credit loans. | The repayment period for an overdraft facility can be monthly, quarterly, half-yearly, or yearly. |
There is a notable difference between overdraft and overdraft based on these parameters.
Important Features Of Cash Credit And Overdraft
We have read above the difference between overdrafts and cash credit. Now, let’s have a look at some important features of cash credit:
1. Borrowing limit: A cash credit has a borrowing limit that is determined by the creditworthiness of the borrower. A business can only withdraw funds up to the amount it has borrowed.
2. Interest: is charged on the operating balance of the cash credit account, not the overall borrowing limit, as it is with other traditional debt financing options such as loans.
3. Charge for a minimum commitment: The short-term loan comes with a minimum price for establishing the loan account, regardless of whether the borrower uses the available credit. For instance, banks frequently include a clause requiring the borrower to pay a minimum amount of interest on a predetermined sum or the amount withdrawn, whichever is greater.
4. Stocks, fixed assets, and real estate: are all common forms of collateral used to secure credit.
5. Credit period: Before the drawing power is re-evaluated, cash credit is usually granted for a maximum of 12 months.
Let’s take a look at the benefits of having an overdraft account:
1. Overdrafts are available from banks up to a certain limit, varying from the borrower to borrower.
2. A running account with an overdraft limit allows you to deposit or withdraw funds at any time up to the established limit.
3. Banks do not charge prepayment penalties on overdraft limits, unlike most loans, where you must pay the penalty if you pay off your loan early. If you pay it off in instalments, you can pay off the overdraft in full without incurring any prepayment penalties.
4. While overdraft loans do not have a set monthly repayment schedule, the amount you owe should not exceed your overdraft limit.
5. When you have the funds, you can pay off your overdraft in various amounts. The EMI method, which is common with most loans, does not apply to overdraft limits.
6. Joint borrowers have access to overdraft limits. However, both applicants are equally responsible for repaying the approved Overdraft limit.
7. On the overdraft amount used by the borrower, the bank charges a predetermined rate of interest. Daily interest is calculated and billed/debited to you every month. The interest rate will increase if you do not pay the due overdraft amount.
Eligibility Requirements And Documentation For Cash Credit And Overdraft
Because there is a considerable difference between cash credit and overdraft, the features of each facility may vary based on the lender you choose. However, the following is a rundown of the general eligibility requirements.
Eligibility Requirements For Availing Cash Credit:
1. Restrictions on age: Almost all lenders have a limit of 25. To learn more, speak with your lender.
2. Years of business experience: This, too, varies depending on which lender you contact. Three years is the general recommendation.
3. Certain lenders demand that you have filed at least one year’s tax returns. You’ll have to include them in your loan application.
4. A working capital loan is available to sole proprietorships, partnerships, limited liability companies, and publicly traded companies.
5. To get a cash credit line, you will need to put up some kind of security. Almost all lenders will accept real estate as collateral. You could even put your company’s assets to use.
Documents For Cash Credit:
- Documents you will require for availing cash credit:
- Financial statements certified by a chartered accountant
- Six-month bank statements
- One-year income tax returns
- Your collateral’s proof
- Records of your loan payments (if applicable)
- Other documents that your lender might ask for
Eligibility Requirement For Availing Overdraft Facility:
- To qualify for a personal loan overdraft, you must meet the following criteria:
- Over the age of 25
- A monthly salary of at least INR35000 is required
- At least six months in the same job is required
- Work experience of at least two years is required
Documents For Overdraft:
- The copies of your salary slip for three months
- Proof of income
- Bank statements for three months
- Proof of your residence
- ID proof
Advantages Of Cash Credit And Overdraft
The advantages of cash credit are as follows:
1. Source Of Working Capital Financing
2. Easy To Set Up
3. It Is A Tax-Deductible Expense
4. The Amount Of Interest That Has Been Charged
5. Flexibility
The Advantages Of Overdraft are as follows:
1. An overdraft is more flexible than a loan because you only borrow what you need at the time, which may make it less expensive.
2. It’s simple to put together.
3. In most cases, there is no penalty for paying off an overdraft sooner than expected.
Disadvantages Of Cash Credit And Overdraft
The disadvantages of Cash Credit include:
1. A high-interest rate
2. Minimum commitment charges
3. Financing source that is only available for a limited time
4. Loan obtaining difficulty
The disadvantages of Overdraft are as follows:
1. Less money to borrow
2. Interest charges
3. Overspending
Know The Similarities Between Cash Credit And Overdraft
Although there are major differences between cash credit and overdraft, there are few similarities:
Cash credit and overdraft are both financial tools that allow companies to borrow money against their financial statements or inventory. Banks select customers for these short-term loans after evaluating their financial situation and relationship with the bank.
Things To Consider When Opting For Cash Credit Or Overdraft Facility
As there are many differences between overdraft and cash credit. So it is highly important to consider these things when opting for cash credit vs overdraft facility are as follows:
1. Rate Of Interest
Compared to an Overdraft facility, the interest rate charged by lenders for Cash Credit loans is lower.
2. Processing Fees
Check or compare the lender’s processing fee, as it may differ from one bank to the next.
3. Minimum Usage Condition
The limit will be higher than 2 lakhs and will be determined by the company’s profile and needs. Whereas the weekly overdraft limit provided by banks to account holders has increased from INR 50,000 to INR 1,00,000. This is following RBI guidelines. It not only applies to current accounts but also to cash credit and overdraft accounts.
4. Account Closing Charges
Banks generally do not charge any additional fees for cash credit if an account is closed within 14 days of its opening. In the event of an overdraft, Yes, in most cases. However, your bank or credit union may require you to settle your balance before closing an overdrawn account. If you want to close your account, contact your bank or credit union and provide them with your account information over the phone or in person.
5. Interest Servicing
Because interest is calculated on the daily closing balance rather than the maximum borrowing limit, repayment is limited to the amount spent from the available limit. Because it is a short-term loan, the repayment period for the amount borrowed on credit is also limited to 12 months or less. The interest rates on your overdraft, on the other hand, will vary depending on how long your fixed deposit has been open. Furthermore, the applicable interest rate for the period for which the money is withdrawn is only 2% higher than the fixed deposit rate.
Conclusion
Both Cash Credit and Overdraft are financial instruments that assist businesses in meeting their working capital needs. Choosing between cash credit and overdraft can be difficult. There is a difference between cash credit and overdraft, even though they appear to be the same product. Make sure you understand the meaning of overdraft and cash credit, as well as the difference between od and cc, before making a decision.
Get in touch with Loaney‘s experts for simple and hassle-free business finance solutions.
Frequently Asked Questions About Cash Credit And Overdraft
Here are answers to the most frequently asked questions about overdraft and cash credit:
1. Which is better, CC or OD?
The interest rate on a CC loan is lower than the interest rate on an OD loan. For both CC and OD, lenders may impose foreclosure penalties. Borrowers must pay 1 to 2% of the loan amount in foreclosure charges. CC is preferable to OD.
2. What is the CC and OD limit?
The maximum available credit for Bank Cash Advance transactions is the cash credit line, which is a portion of the total credit available on your credit card. The bank sets a limit, and your account can only go negative up to that amount.
3. What are the merits of cash credit?
The merits of cash credit are: fulfils working capital requirements, interest is levied on the amount utilised, Flexibility, easy arrangement, and the interest is tax-deductible.
4. Is cash credit a secured loan?
Yes, cash credit is a secured loan as it is given against collateral security.