Businesses often face short-term cash flow gaps. To bridge this gap, two popular financing tools, overdraft and cash credit (CC), offer quick access to funds. Overdraft allows you to withdraw beyond your account balance within a set limit, whereas cash credit provides working capital against collateral. This guide breaks down their key differences to help you make an informed choice. Read on!
What is an Overdraft?
An overdraft is a credit facility linked to your bank account that lets you withdraw more than your available balance, up to a set limit. For example, with ₹50,000 in your account and a ₹1 lakh overdraft limit, you can access ₹1.5 lakh. Interest is charged only on the amount used, not the full limit. Overdrafts are popular among individuals and small businesses for quick liquidity, and can be secured (e.g., against FDs or property) or unsecured.
What is Cash Credit?
Cash credit is a short-term working capital loan designed to help businesses manage their daily expenses, including inventory, raw materials, and wages. The credit limit is based on the value of collateral (such as shares, receivables, or other company assets). Just like an overdraft, the interest is levied solely on the amount you have withdrawn.
Unlike overdrafts, cash credit typically involves larger sums and supports ongoing operational needs.
Read Also: Cash Credit Loan - Features, Eligibility, & How to Apply
Overdraft vs Cash Credit: Key Differences to Know
Here are the key differences between overdraft and cash credit:
|
Point of Difference |
Overdraft |
Cash Credit |
|
Purpose |
It is ideal for filling modest and unexpected financial shortfalls.
|
It is generally used for business operational needs, such as providing funds for daily needs, including raw supplies, payroll, and bills. |
|
Loan Amount Determination |
The bank often determines your limit depending on your income, savings, or fixed deposits. For NBFCs, this may be determined by your account history and the institution's relationship with you. |
The value of your business assets, such as stock or invoices, determines the maximum amount. For example, if your firm has stock worth ₹20 lakh, the bank may grant you a cash credit limit of ₹15 lakh. |
|
Interest Rates |
The interest rate is usually slightly higher, especially if it is unsecured.
|
Here, it is slightly lower because you provide collateral. Borrowing large sums regularly might make cash credit more cost-effective than repeated overdraft.
|
|
Loan Tenure and Renewal
|
They are often short-term. Banks regularly examine limits, typically every three months, and renew them annually.
|
It is approved for 12 months, with an annual review. Banks may request stock statements or sales information throughout the year. Overdrafts are evaluated more regularly than cash credit, which is a more structured facility. |
|
Collateral / Security
|
It can be unsecured. Deposits or property are occasionally used as collateral.
|
It requires collateral, such as shares, receivables, or other assets. |
|
Eligibility and Documentation
|
If you currently hold a bank account, you'll need a minimum of KYC and financial documents. |
Requires documentation, such as financial documents, stock data, and business performance reports. |
Overdraft vs Cash Credit: Advantages and Disadvantages
To decide which facility suits you best, let’s understand the benefits and disadvantages of overdrafts and cash credit.
Advantages & Disadvantages of Overdraft
|
Overdraft Advantages |
Overdraft Disadvantages |
|
Quick and easy access to cash without the need for extensive documentation |
Offers a lower limit than cash credit |
|
Interest is levied only on what you use |
Unsecured loans, thus, may have higher interest rates |
|
Flexible repayment plans without set EMIs |
If there is minimal activity on the account, the facility may be discontinued. |
|
Helps manage unexpected and urgent expenses |
- |
Advantages & Disadvantages of Cash Credit
|
Cash Credit Advantages |
Cash Credit Disadvantages |
|
Increased credit limits to facilitate corporate operations. |
Requires collateral, such as shares or receivables. |
|
Interest is levied based on use rather than full sanction. |
Extensive documentation and monitoring are required. |
|
Suitable for ongoing and predictable working capital requirements. |
Business sales are evaluated regularly, and businesses are required to provide regular updates. |
|
It helps firms handle their receivables and payables efficiently in predictable situations. |
- |
Overdraft vs Cash Credit: Which is Better?
Choosing between an overdraft and a cash credit depends on your business profile and your specific financial requirements.
When does an overdraft work better for you?
An overdraft is an excellent option if you:
● Own a small business, freelance, or are a professional who
experiences unexpected cash requirements.
● Simply need money
occasionally, not daily.
● Don't want to deal with excessive
documentation or pledge assets.
● Like the notion of paying
interest only on what you really use.
For example, suppose you own a design studio. A client's payment has been delayed, but you still must pay rent and salary this month. An overdraft connected to your current account can swiftly replace this deficit with no effort. Once the client pays, you can clear the overdraft, and the facility will remain accessible for future use.
When does a cash credit work better for you?
Cash credit is often more favourable if you:
● Run a business whose working capital requirements are
constant and continuing.
● Require a greater limit to handle
inventory, raw materials, and supplier payments.
● Can
provide collateral such as goods, receivables, or property.
For example, let’s assume that you run a small manufacturing business. Every month, you purchase raw materials in bulk, pay employees, and wait 45-60 days for clients to pay invoices. In such instances, cash credit guarantees that you always have enough funds to keep operations running smoothly, without having to worry about delayed payments.
ALSO READ :- Pros & Cons of Revolving Credit for Business – Quick Guide
To Conclude
Both overdrafts and cash credit serve as valuable tools for your business financing needs, but the best option depends on your specific needs. Overdraft is a flexible and straightforward option for obtaining funds to meet short-term needs. However, if your business frequently requires capital for day-to-day operations, cash credit may be a better choice.
FAQs
Can individuals obtain a cash credit
facility?
No, cash credit is intended for businesses.
Individuals can instead apply for an overdraft or a Personal Loan.
Which is cheaper in terms of interest rates, Cash
credit or overdraft?
Cash credit often has lower
interest rates as it is collateralised. Overdraft interest rates may
be higher, particularly if the account is unsecured.
Can I change my overdraft to a cash credit facility
later?
Yes, you can. Many businesses begin with an
overdraft for minor purchases and then transition to a cash credit
facility as their working capital demands increase.
How do overdrafts and cash credit impact my credit
score?
Like other loans, making timely payments and
using your credit responsibly can boost your credit record, but
defaults or excessive utilisation can negatively impact it.
Can startups and newly established businesses seek
cash credit?
Generally, banks demand a proven
business track record and collateral before issuing a cash credit.
Startups may find it easier to get business loans or overdrafts
from the NBFCs during the early stages.
We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Loan disbursal is at the sole discretion of Poonawalla Fincorp.
*Terms and Conditions apply