The majority of the people are unable to differentiate between the bank overdraft and the cash credit which is the facility that is being provided by the bank.
In this blog, we would get to have a better understanding of the cash credit and the bank overdraft and the difference between them
Cash Credit
Cash credit is a type of short term loan facility offered to the companies to manage the working capital needs against the mortgage of inventory such as raw materials, finished goods, a guarantee of debtors, or other securities as per bank norms. The amount is credited into a separate account which is neither the current nor the saving one. The cash credit limit is supposed to be equal to the working capital requirement of the company less the margin funded by the company itself.
Overdraft
Overdraft means the act of overdrawing money from the bank account. Bank overdraft is the facility provided by the bank to its customers to withdraw money more than the amount that he/she holds in their account. It is a continuous facility offered by the banks and it is linked to the current account of the company. It is offered against the financial instruments or the property as the mortgage.
Key Differences between Cash Credit (CC) and Overdraft (OD)
The Key Differences between the Cash Credit and the Overdraft are:
| Parameters | Cash credit | Bank overdraft |
| Types | Cash credit is divided into two types: Key Cash Credit & Open Cash Credit | Bank overdraft can be divided into two types: Secured Overdraft & Clean Overdraft |
| Account type | The borrower must have a cash credit account with the bank or financial institution | The borrower must have a current account with the bank |
| Security | The cash credit facility is given against the pledge or hypothecation of inventory or other current assets or collateral security. | Overdraft facility is given against the security of fixed assets |
| Withdrawal facility | A cash credit option allows one to receive funds at a go as per the amount approved | An overdraft facility enables multiple withdrawals from the total funds available. |
| Interest charge | Interest calculation on the cash credit is done on the entire amount provided by the lender | Interest accruals occur only on the amount withdrawn by the borrower and not on the total amount sanctioned |
What are the similarities between Cash Credit & Bank Overdraft?
There are a few similarities between the two:
- Both are payable on demand
- More money can be withdrawn than the money in the account
- Both need to pledge a security
- Both are Line of Credit facilities
- Amount limit has been set for both
- Both are short tenure road
The interest rate for the cash credit
Interest on the cash credit is calculated on the daily utilization of the limit. It can be explained with an example
Balance as of 01.09.2020=1,50,000/- ROI= 11.5% next transaction was done on 02.08.2020 at means balance of Rs.1,50,000/- remained outstanding for one day, the calculation of interest will be as follow:-
150000×11.5×1 /36500= 47.26
If the next transaction was done on 05.08.2020 at a means balance of Rs.1,50,000/- remained outstanding for four days, the calculation of interest will be as follow:-
150000×11.5×4/36500= 189.04.
The interest rate for the Overdraft
There is no uniform rate of interest for overdrafts. It differs according to the nature of the industry and the nature of the facility.
Banks are not collecting the same rate of interest and it is purely the discretion of the individual banks
Let us imagine that the Marginal Cost of Fund Based Lending Rate (MCLR) is 9.70 %. Normally the rate of interest for an overdraft will not be more than 3 percent above the bank rate and in such case, the rate of interest will be 12.70 percent.
Disadvantages of a Cash credit
- Minimum Commitment Charges
Whether the company utilizes the cash credit or not, a minimum commission charge is imposed
- The high rate of Interest
The interest rate charged on a cash credit loan is very high compared to traditional loans.
- Strict Eligibility Criteria
It is difficult to obtain a cash credit loan as there are certain criteria’s like borrower’s turnover, account receivable balance, expected performance, and collateral security offered.
- Source of finance is momentary
It is a short term loan and cannot be relied on for an extended period
Disadvantages of Bank Overdraft
- Higher Interest Rates
The cost of borrowing is usually higher than the other source of borrowing
- Risk of Reduction in Withdrawal Limit
Reduction in the withdrawal of limit may happen usually when company financials may represent poor performance; hence, the facility may be withdrawn especially when there is the utmost requirement
- Risk of Seizing
Bank overdraft may at times is secured against the security or other collaterals like shares, life insurance. If the payment is not done on time then there is the possibility of an asset getting seized
- Ignoring the debtor’s Collection
At times, the availability of an overdraft facility may make the company less strict on the collection of debtors’ payments if they are getting immediate payment from the overdraft facility.
Both cash credit and the overdraft facility are the important loan facilities that bail out the customers whenever there is dire need as it is the fastest source of getting the fund.
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