In the realm of banking and finance, terms like 'cash credit' and 'overdraft' are commonly used but often misunderstood. While both serve as financial instruments provided by banks to individuals and businesses, they serve distinct purposes and come with unique features. This guide clarifies their definitions, functionalities, and key differences.
What is Cash Credit (CC)?
Cash credit is a short-term loan facility extended by banks to businesses based on their creditworthiness and collateral. It allows businesses to withdraw funds up to a specified credit limit as needed — similar to a revolving line of credit.
How Cash Credit Works
- Credit Limit: The bank sets a maximum credit limit based on the borrower's creditworthiness, financial standing, and value of collateral (typically stock, receivables, or property).
- Withdrawal: Borrowers can withdraw funds up to the sanctioned limit as per their requirements at any time.
- Interest Charges: Interest is charged only on the amount actually withdrawn, not on the full sanctioned limit. This makes CC very cost-effective for businesses with fluctuating needs.
- Repayment: Repayment is flexible — businesses repay as and when they receive payments from customers, continuously reducing and re-drawing from the limit.
- Collateral Required: Typically required — stock-in-trade, book debts, fixed deposits, or property.
What is an Overdraft (OD)?
An overdraft is a financial arrangement that allows an account holder to withdraw more than the current balance in their bank account — up to a pre-approved overdraft limit. It serves as a short-term borrowing facility to cover temporary cash flow shortages.
How Overdraft Works
- Linked to Account: Unlike cash credit (which has a separate loan account), overdraft operates directly through your current or savings account.
- Approval & Limit: The bank approves an overdraft limit based on your credit history, income, assets, or relationship with the bank.
- Interest: Interest is charged only on the amount overdrawn and for the exact number of days it remains outstanding.
- Collateral: May or may not require collateral — clean overdrafts (against creditworthiness/salary) require none; secured ODs require FDs, property, or insurance policies.
- Repayment: Repayable on demand by the bank — most OD facilities are reviewed and renewed annually.
Cash Credit vs Overdraft — Key Differences
| Parameter | Cash Credit | Overdraft |
|---|---|---|
| Purpose | Working capital for businesses | Short-term liquidity for individuals/businesses |
| Account | Separate CC loan account | Operates through existing current/savings account |
| Collateral | Usually required (stock/receivables) | May or may not be required |
| Borrowers | Primarily businesses | Individuals and businesses both |
| Limits | Higher limits possible | Generally lower, based on salary/FD/property |
| Typical Tenure | 12 months, renewed annually | On demand, reviewed annually |
| Interest Basis | On amount drawn | On amount overdrawn |
Which Should You Choose?
Choose Cash Credit if you are a business with recurring working capital needs, large inventory requirements, or need a high credit limit against your business assets.
Choose Overdraft if you need a buffer for short-term personal or business cash flow gaps, especially if you have fixed deposits, a strong salary, or an LIC policy to offer as security for a secured OD.