Know the Difference Between and Cash Credit and Overdraft

Cash credit and overdraft are the two most popular short-term financing options. While both offer quick access to funds, they differ in key aspects, influencing the suitability for customers. Understanding these differences is crucial for making informed financial decisions. Read on to have a comprehensive idea about the differences between overdraft and cash credit. 

What is the Cash Credit Facility?

Cash Credit is a credit facility used mostly by businesses to meet their short-term working capital needs. This type of loan is especially useful when a company experiences an unexpected need for funds, such as when purchasing raw materials. Businesses can pledge collateral, such as property, stocks, fixed deposits, or even inventory, to obtain cash credit with a tenure of up to 12 months.

It is important to note that cash credit loans are typically not high in value, given their short-term nature. Nonetheless, they can be a valuable resource for companies needing quick access to enough working capital to keep their operations running smoothly. With cash credit, businesses can rest assured that they have a reliable source of funding to cover their short-term financial needs.

What is an Overdraft Account?

The overdraft facility allows both individuals and businesses to withdraw funds exceeding their available balance up to a pre-approved limit. This essentially allows them to borrow money from a bank to cover temporary shortfalls. Overdrafts are typically unsecured, meaning they do not require collateral.

Also Read: Understanding the Key Differences Between Term Loans and Cash Credit

Overdraft vs. Cash Credit: Key Differences

Choosing between an overdraft and cash credit facility depends on several factors, including interest rates, security requirements, intended use, and repayment terms. Let us dive deeper into the key differences:

Points	Cash Credit	Overdraft
Purposes	Primarily used for business purposes (especially as working capital) such as purchasing inventory, paying for raw materials, or covering payroll expenses.	Can be used for various purposes, including covering temporary cash flow gaps, unexpected expenses, or seasonal fluctuations.
Loan Amount	The loan amount is typically based on the value of the collateral provided by the business.	The limit is determined by the bank based on the business's financial health, credit history, and past banking relationships.
Limit	The limit remains constant throughout the facility's tenure.	The limit may be reviewed periodically by the bank based on the business's performance and account activity.
Interest Rates	Generally, cash credits offer lower interest rates compared to overdrafts due to the presence of collateral, which reduces the bank's risk.	It carries higher interest rates as they are unsecured and involve a higher risk for the bank. Interest is usually charged daily on the utilised amount.
Tenure	Cash credit has a longer tenure, ranging from one year to three years, with the possibility of renewal.	Overdraft has a shorter tenure, ranging from a few days to a year, depending on the bank's policy and repayment history.
Security	Requires collateral, such as inventory, receivables, or property, to secure the loan. This provides the bank with a safety net in case of default.	Usually unsecured, meaning no collateral is required. However, some banks may ask for a personal guarantee from the business owner or directors.
Account	Often requires opening a separate account specifically for managing the credit facility.	Linked to an existing current account, offering quick access to funds.
Applicants	Generally available to established businesses with a good record of accomplishment and sufficient collateral.	More readily available to both established and new businesses with a decent banking relationship and credit history.

 

What Are the Similarities Between Overdraft and Cash Credit?

Following are some of the most important similarities between overdraft and cash credit:

• The lender charges interest on the amount of money utilised for both cash credit and overdraft, not on the sanctioned amount or limit.
• Financial institutions offer these credit facilities against the collateral of current assets.
• Both credit overdraft and cash credit are repayable on demand.
• In both cases, the loan limit or amount that is sanctioned stays fixed, and borrowers cannot withdraw any additional money.

Factors to Keep in Mind While Choosing Overdraft or Cash Credit

Here are some of the most important factors you need to keep in mind when you apply for an overdraft or cash credit:

• It is essential to check and compare the processing fees charged by lenders as they may vary from lender to lender.
• Certain lenders may charge foreclosure fees if a borrower wishes to foreclose their loan. These fees typically range from 1% to 2% of the loan amount. Borrowers need to be aware of these potential charges when considering closing their cash credit or overdraft loan account.
• Banks offer a particular predetermined amount of cash credit based on the stocks' pledged value. Some financial institutions charge extra fees for the amount you do not use from your defined loan amount.

Also Read: Credit Card Future in India: What's in Store?

To Conclude

Financial institutions offer various types of short-term financing products to the borrowers, including cash credit and overdrafts. Although these two options may seem similar, they have distinct differences in terms of their financial aspects. Businesses favour both overdrafts and cash credit as there is minimal documentation required. Cash credit is the best option for cash credit, whereas overdrafts can be the better option for individual account holders.

Disclaimer

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.
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