Cash Credit vs Overdraft: Key Differences to Know

Access to the right financial tools can distinguish between thriving and barely surviving. Business owners, especially those managing small to medium-sized enterprises, must be aware of different financial options to manage their cash flow effectively.

Business owners can utilise two such popular credit facilities: cash credit and an overdraft. While they may seem similar initially, understanding their nuances can help you make smart financial decisions. This blog highlights the difference between cash credit and overdraft, helping you know these financial tools better.

What is cash credit?

Cash credit (CC) is a short-term loan banks offer businesses to fulfil their working capital requirements. It allows them to receive funds up to a specific credit limit, even if their account balance is low, zero, or below.

Businesses can secure cash credit against fixed assets such as property or company inventory or other financial assets such as Fixed deposits (FDs) or stocks. One key benefit of cash credit is its flexibility.

The business can withdraw money as needed, and interest is charged only on the amount utilised, not the entire credit limit. This flexibility makes cash credit an attractive option for businesses with fluctuating cash flow needs.

What is an overdraft?

An overdraft (OD) is another form of short-term finance, allowing existing account holders to withdraw more money than they have in their bank accounts. Unlike cash credit, an overdraft is usually linked to the business's existing accounts and does not require separate collateral or the opening of a new account.

The overdraft limit is usually based on the account holder's creditworthiness and past banking relationship. The main advantage of an overdraft is its convenience. Business owners can easily access extra funds without going through a lengthy loan approval process.

An overdraft can be particularly useful for covering short-term cash flow gaps or unexpected expenses. Similar to cash credit, interest rates on an overdraft are also charged only on the amount withdrawn, not the entire limit.

Similarities between cash credit and overdraft

While both lines of credit – cash credit and overdrafts – serve different purposes and have different terms and conditions, they share some similarities.

Cash credit and overdraft facilities provide short-term funds to businesses when needed.
Interest is charged only on the amount utilised, not the loan amount sanctioned.
The money withdrawn cannot exceed the total amount offered in both types of business loans.
In both cases, the loan is offered against collateral and is repayable on demand.

Difference between overdraft and cash credit

While cash credit and overdraft facilities share some similarities, they also have distinct differences that may impact your decision-making process. Understanding these key differences is crucial for choosing the ideal option for your business.

Feature	Cash Credit	Overdraft
Best for	Helps businesses manage working capital and operational expenses	Used by individuals and businesses for handling emergencies and short-term expenses
Interest rates	Charges are lower than overdrafts	Are comparatively higher
Security	Pledged against the business inventory and stocks	Can be availed on financial standing, banking relationship, credit history, and investments
Account	Need to open a new account	Can use the existing bank account
Loan term	Minimum of 1 year	Ranges from a month, a quarter, to even a year
Limit	Based on business turnover and collateral	Based on the account balance and the past banking relationship

Factors to remember

Choosing between cash credit and overdraft depends on your business's requirements and goals. No matter which option you choose, have an open conversation with your lender regarding the factors mentioned below:

Processing fees: A small fee is charged to process your loan application. To ensure a fair deal, check with your lender and compare the amount levied with other lenders.
Foreclosure charges: Check with your lender/bank to see if they levy any foreclosure fees. If you (the borrower) want to close the loan earlier than decided, a certain percentage of the loan amount will be charged as a penalty.
Loan amount utilisation: If the cash credit facility is issued but not used after a certain period, some banks/lenders may also charge interest on the unused amount.

There's no one-size-fits-all answer to the debate of overdraft vs. cash credit. Both financial tools offer unique advantages and can benefit business owners. Understanding the differences between cash credit and overdrafts lets you choose the best option for your business goals.

Effective financial management is critical to ensuring your business's growth and success. Platforms like Quid can help you find the best business loan that matches your needs in just a few clicks. Know more about how we can help your business thrive with the right financial support.