All small and medium businesses require sufficient working capital to run their daily operations successfully. The two popular choices available to companies when taking a loan are:
Long-term loans like small business loans, line of credit, etc.
Or short-term flexible loans like cash credit and overdraft.
Very often, businessmen assume that both cash credit (CC) and overdraft (OD) are the same. While these two short-term loan options may appear similar, they are two vastly distinct financial solutions catering to different requirements. Here, in this article, let's take a closer look at the differences between CC and OD, helping you understand the right one for your specific business needs.
What is cash credit?
Cash credit (CC) is a small business loan that is offered for one year. Generally, it is used to meet the working capital needs of a business.
Key points to know about cash credit:
You can use the funding only for business-related purposes.
You need to open a separate bank account to receive the amount from the cash credit.
There is no limit on the number of transactions and the cheque books issued for the cash credit account.
Borrowers are required to submit the following documents once every quarter and annually – the profit and loss statement, balance sheet, GST filing, etc.
Generally, lenders require the borrower to submit collateral to avail cash credit loans.
The loan can be repaid daily or weekly, based on the terms and conditions stipulated by the lender.
What is an overdraft?
Overdraft (OD) is a facility extended by banks to select customers. It allows current account holders to withdraw more money from their bank account, than what is available. This way, you can issue cheques even if you have insufficient balance in your account.
Key points to know about overdraft:
An overdraft facility is available only to reputed customers. Banks offer this facility to customers who have a good relationship with the bank and a sound financial position.
The bank charges fees for this facility. The amount of fees charged depends on the extra amount you withdraw from your account and varies from one bank to another.
Similarities between Cash Credit (CC) and Overdraft (OD)
Both cash credit and overdraft are financial instruments that help businesses borrow money against inventory or financial statements. Both CC and OD are offered by banks to select customers after evaluating their financial standing and considering their relationship with the bank.
Here are a few other similarities between cash credit and overdraft:
The interest rate for CC and OD is charged on the amount of money utilized and not on the total amount sanctioned.
Both these products are offered against the security of current inventory or other business assets.
The maximum amount sanctioned is fixed, and borrowers cannot qualify for additional money.
Differences between Cash Credit and Overdraft
While CC and OD may be similar, there are several differences between these two financial products.
|Interest rates are lower compared to OD.||Interest rates are higher than CC.|
|Cash credit is offered based on available stocks and inventory.||The OD amount is determined based on the client’s relationship with the bank, investments like insurance policies, FDs, credit history, etc.|
|The funds should be used only for business needs.||The usage of funds is not as strict as CC.|
|A new account must be opened to receive the cash credit loan.||The OD facility can be applied to the existing account of the borrower.|
|The tenure is generally one year (minimum).||The tenure is much shorter and can be for a month, quarter, or half-year. The maximum tenure is one year.|
|The cash credit amount sanctioned does not reduce over time.||When it comes to OD, the amount reduces monthly.|
|It can be availed by traders, distributors, companies, sole proprietorships, partnerships, LLPs, and even individuals.||It is available only for account holders of the respective bank.|
Few Points to Keep in Mind, while Choosing CC or OD:
Make sure to keep an eye on the processing fee charged by the bank. Note that this amount varies from one bank to another.
The interest rate for a CC loan is significantly lower than the interest rate charged for an OD.
Some lenders may charge foreclosure penalties for both CC and OD. Generally, borrowers have to pay 1 to 2% of the loan amount as foreclosure charges.
Opt for Cash Credit or Overdraft to Meet your Working Capital Needs
Both CC and OD act as handy financial tools to help businesses meet their working capital needs. While these two products may appear similar, they are different. So, make sure to understand the features and other additional fees before you choose the right product. Alternatively, if you're looking for long-term loans, then a small business loan may be the better choice as the interest rates are significantly lower.