Cash Credit vs. Overdraft: Which is best for your business?

3 MinsMar 17, 2023

Running a business is like sailing a ship; you can never be fully prepared. Hence, despite having strategies in place, businesses may need more funds due to multiple reasons like delays in receivables, emergencies and capital expenses. Banks offer cash credit, overdrafts and other facilities, but the challenge is understanding the features and choosing the best option.

Cash Credit vs. Overdraft: Which is best for your business?

What Is Cash Credit?

Cash Credit is a short-term loan that a company or business can avail of to meet their working capital needs. Typically, it is used to tide over a short-term need for funds that may crop up suddenly. For example, a company needs funds to purchase raw materials. In such a situation, the company can pledge some collateral with a bank and take a loan having tenure of up to 12 months to meet this urgent need for cash. The amount of loan available in a Cash Credit is not high, as it is a short term loan. The collateral could be fixed assets, such as property or financial assets such as Fixed Deposits or stocks. It could also be inventory of goods manufactured by the company.

Cash credit is a short-term finance option that businesses can avail of. Businesses hypothecate their assets like stock and inventory to avail the credit. This can be used to fund their working capital requirements.

What Is Overdraft?

Overdraft, on the other hand, is an overdrawn Current Account. This facility allows payments to be made from the account despite the shortage of funds. This facility can be availed by sole proprietors by opening an Axis Bank Liberty Digital Current Account for Sole Proprietorship instantly with PAN. They can enjoy more benefits like deposits, withdrawals and overdrafts. So instead of a Savings Account, a sole proprietor can benefit from a Current Account that can be overdrawn. Even companies can benefit from an overdraft facility.

Similarities between Cash Credit and Overdraft

  • Both cash credit and overdraft are lines of credit facilities offered by banks.
  • Both cash credit and overdraft charge interest on the utilised amount and not on the sanctioned amount.
  • Both cash credit and overdraft are offered to businesses.
  • In both cases, the amount withdrawn cannot exceed the sanctioned amount.

[Also Read: Complete guide to opening a Current Account]

Differences between Cash Credit & Overdraft

While there are similarities between cash credit and overdraft there are some major factors that distinguish the two. They are as follows:

Cash credit and overdraft have the following distinct features:

BasisCash CreditOverdraft
Interest RatesComparatively lower interest rateComparatively higher interest rate
SecurityOne must pledge their stocks and inventory as collateralCan be obtained based on financial standing, credit history, investments, and banking relationship
UsageTypically intended for business purposes, particularly as working capitalUsed for any general purpose, including business expenses
Loan AmountDetermined by the volume of stocks and inventoryBased on financials and security deposits
LimitRemains unchangedDecreases every month
AccountNew bank account must be openedCan be accessed through an existing account
TenureMinimum tenure of 1 yearCan range from a month to a maximum of 1 year
ApplicantsIndividuals, traders, manufacturers, retailers, distributors, partnerships, companies, sole proprietorships, LLPs, etc.Only account holders of the specific bank

Points to Remember

While both cash credit and overdraft provide businesses with much-needed funding you must consider the following points before availing of any of the facilities:

Interest Rate - The interest rate offered for both services must be compared since interest for cash credit is lower.

Foreclosure charges - The foreclosure charges are applicable when the credit facility is no longer needed and closed before its tenure. These charges usually range from 1% to 2%.

Processing Fee - The fees for processing must also be looked into.

Loan amount utilisation - If the cash credit facility is availed but not utilised, then banks may charge interest on the unutilised amount also.

Penalty charges - Some banks also levy penalty interest.

The most suitable option will depend on your business's specific needs and circumstances.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.