Cash credit is a short-term loan that companies and businesses get to meet their working capital expenditure. An overdraft is a facility given by the bank to individuals and companies. So, they can withdraw money from their bank account, even if there is a low, zero, or below the balance. Most people and small businesses consider cash credit and overdraft the same. But it’s not true; both have different properties and purposes for achieving. Read this article to know both systems’ major differences and working processes.
How Does Cash Credit Function?
Cash credit is mostly provided to businesses rather than individuals, as businesses have to maintain their working capital. To provide this service, financial institutions, banks, and NBFC mostly ask users to put down a form of security as collateral. So, financial institutions and banks can provide cash credit to the user. Mostly, the collateral security must be a tangible asset, stock, or even property. Banks can expand the credit limit based on the collateralized security’s value. It’s a short-term financing scheme provided by banking and NBFCs to their customers. If businesses do not have working capital, they can use this facility where they have to pay a low-interest rate on the account’s daily closing balance.
Furthermore, it is also called a cash reserve account and is considered an unsecured line of credit like an overdraft. It provides a higher credit limit than the regular overdraft service provided by the bank. Also, banks charge a lower interest rate to keep this financing facility affordable for small businesses.
How Does an Overdraft Function?
Overdraft is also a financing facility the bank provides to individuals and businesses. Banks usually provide an overdraft facility against the amount in the user’s account. If the customer does not has a sufficient fund in their account, they can still use this facility, but their account will go into negative. For example, if Mr. A has Rs 10,000 in his account and writes Rs 11,000 check. In that case, the bank can allow him to overdraw from his account to cover the mentioned amount in the check.
However, now Mr. A will have (-1000) in his account. Here banks use the common term overdraft protection, which means the case when users will have below zero balance in their account. It has many use cases and functionality depending on the banks and users’ relationship with each other. Here banks often charge service charges when users get overdraft service and deduct interest on the amount. An overdraft can be used as an emergency loan at comparatively low charges.
Difference between Cash Credit and Overdraft
| Cash Credit (CC) | Overdraft | |
| Meaning | Cash credit is the form of short-term loan that financial institutions and banks mainly provide to help businesses to meet their working capital requirements. | Overdraft is the bank’s service and is treated as a loan facility. It is provided to individuals and businesses based on the relationship with the bank. Banks allow their users to withdraw a greater amount than the available balance in their accounts. The banks or the financial authority can fix the withdrawal limit. |
| Objective | The objective of the issuance of cash credit is to help businesses to maintain their working capital. | Overdraft facilities help users to meet their short-term objectives. |
| Interest Rate | Overdraft facilities help users to meet their short-term objectives. | The interest rate charged on overdraft service is greater than the interest charged on cash credit. |
| Account Type | Users need to open a new account to get this service from banks. | Users can avail of this facility from the bank using their existing account. |
| Interest Calculation Method | Here banks calculate the interest rate on the entire amount withdrawn by the user. | Bank calculates the interest amount on the amount that the user avails. |
| Loan Duration | In the case of cash credit, the loan duration generally stands around one year. | The loan duration under the overdraft facility can be monthly, quarterly, half-yearly, and even yearly. It all depends upon the bank and users’ mutual consent. |
| Users | In general, cash credit facilities are availed mostly by businesses. | Individual customers mostly use overdraft facilities than businesses. |
| Requirements | Users need to fill out a form of security as collateral. Here users can keep stock or property as collateral or security. | Mostly overdraft facilities are provided against the fixed asset. |
| Arrangement Type | Cash credit revolved around arrangement-type financing. | In contrast, the overdraft is not an arrangement-type short-term loan facility. |
| Maximum Limit | It can be up to 60% of the inventory and receivables. | For unsecured overdrafts, banks usually fix the maximum limit. At the same time, banks keep up to 85% of asset value under secured overdraft. |
| Changes in Withdrawal Limit | The withdrawal limit can be changed based on inventory, and receivables change from time to time. | There is not any chance of changing the withdrawal limit. |
Are There Any Similarities between Cash Credit and Overdraft?
As mentioned below, there are some key similarities between cash credit and overdraft.
- The banks and financial institutions charge interest on both cash credit and overdraft.
- Both CC and overdraft are repayable on demand, plus both are availed against current assets.
- Banks keep the loan limit fixed to some extent, and users can not increase the limit to get more funds.
Conclusion
Cash credit and overdraft are good short-term financing facilities provided by banks and financial institutions. However, most businesses and individuals consider this banking financing service the same. But these are not the same in the objective and use cases. However, they may carry a few similarities as both are short-term loans used by their users.
Thus, we hope now you have a clear understanding of the difference between cash credit and overdraft. If you keep willing to learn about such interesting topics around finance. You can stay tuned to our website, as we share interesting and helpful posts regularly. Also, if you liked this article, please share this with your friends and leave a comment to support us.