Difference Between Cash Credit and Overdraft (Key Differences Explained) Daily Journal

Published on: September 13, 2024

Financial institutions provide many credit solutions to businesses and individuals facing fluctuations in cash flow or urgent expenses. Two commonly available options are cash credit and overdraft. While both facilities allow you to borrow beyond your immediate resources, they serve different purposes and operate under different terms.

Whether you need to finance business operations or cover personal expenses, it is important to understand how these facilities differ and can help manage your money effectively.

First, let us understand the meaning of cash credit and overdraft.

What is cash credit?

Cash credit is a type of short-term loan that companies or businesses can use to meet their immediate needs working capital needs. It is usually used to deal with unexpected financial requirements, such as purchasing raw materials or covering operational expenses. The borrower can secure this loan by pledging collateral, which can be property or financial assets such as fixed deposits or stocks, or even stock of goods manufactured by the company.

Cash credit provides businesses with access to a set amount of funds without maintaining a credit balance, making it flexible to manage short-term cash flow issues.

Eligibility for cash credit depends on several factors, including the company’s credit history, type of collateral, credit score, and current assets and liabilities. This type of financing benefits small businesses that need access to capital without the need for long-term borrowing.

What is an overdraft?

An overdraft is a type of financing offered by financial institutions that allows account holders to withdraw more money than is available, resulting in a negative balance. Simply put, when you spend more than you have in your account, the overdraft covers the deficit, but it must be repaid.

Advance financial institutions Overdraft facilities As a form of credit. You can access a certain amount of funds beyond your available balance, and interest is charged only on the amount withdrawn. This service usually has fees and benefits, which makes it important to manage it carefully.

The difference between overdraft and cash credit

To make it easier for you, here are the main differences between overdraft and cash credit.

face	Cash credit	Overdraft
very	The cash credit loan facility enables businesses to meet their working capital requirements.	Both individuals and businesses can avail overdraft facilities to cover short-term financial needs and manage immediate expenses.
nature	It acts as a revolving line of credit for businesses	Borrowing beyond the available account balance is permitted
Interest rates	It usually comes with lower interest rates	Interest rates are higher in comparison
Account requirements	Requires opening a new account	It can be accessed through an already existing account
Loan term	The duration may vary, but most financial institutions offer up to one year	The duration may vary depending on the financial institution
Collateral requirements	It requires pledging assets such as inventory or shares as collateral	Guarantees may be required in some cases
Target users	Primarily used by businesses	Available to both individuals and companies

Points to consider while availing cash credit or overdraft

Both cash credit and overdraft provide financial support, but it is important to consider several factors before choosing either option:

1. Interest rate

compare Interest rates Provided by your financial institution. Cash credit generally comes with a lower interest rate compared to an overdraft, making it more cost-effective for long-term business needs.

2. Mortgage fees

If you plan to close the credit facility before the agreed upon term, you may be charged certain foreclosure fees ranging from 1% to 2% of the loan amount.

3. Processing fees

You should take into consideration the processing fees associated with both facilities. These fees may add to your overall expenses, so it’s important to take them into consideration when evaluating options.

4. Use of the loan

In some cases, especially with cash credit, if the entire approved amount is not used, the financial institution may still charge interest on the unused portion. You should ensure that you understand the conditions relating to the use of the loan before choosing any facility.

5. Penalty fees

You should check for any interest or penalty fees that some financial institutions may charge for exceeding the permissible limit or not adhering to the agreed terms. Considering these potential fees will help you avoid unnecessary costs.

conclusion

While both cash credit and overdraft provide convenient methods of financing, they serve different purposes. Cash credit is allocated to businesses that need fixed working capital, at low interest rates and Requires guarantees. Overdrafts provide greater flexibility for both individuals and businesses to deal with short-term financial gaps, although they often come with higher interest rates. Understanding the differences between the two can help you choose the most suitable option based on your financial requirements.

Frequently asked questions

Which is more convenient for businesses, cash credit or overdraft?

Cash credit is generally more suitable for businesses because it helps in managing regular operational expenses in the long term. While an overdraft is often used for temporary cash flow shortages. To find the most suitable facility for your business, consider interest rates, repayment terms and the amount of financing required.

How is interest calculated on cash credit and overdraft?

In both cash credit and overdraft, interest is charged only on the amount that has been used, not on the total limit.

What type of collateral is required to obtain cash credit?

Cash credit generally requires companies to pledge assets such as property, inventory, fixed deposits or shares as collateral.

What factors affect the approval of an overdraft facility?

Approval for an overdraft depends on factors such as the borrower’s credit score, financial situation, and sometimes collateral or available investments.

What happens if I exceed the approved limit for cash credit or overdraft?

If you exceed the limits allowed by either facility, the financial institution may impose a penalty or higher interest rates. It can also affect your credit score and your ability to borrow in the future.