CASH CREDIT

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    Cash Credit (CC) is a source of short term finance for businesses and companies. Cash credits are also called working capital loans as they fund the instant cash requirements of the organizations, or to purchase current assets.... Cash credit is a loan and banks demand collateral to approve it.

    Important Features of Cash Credit

    1. Borrowing limit

    A cash credit comes with a borrowing limit determined by the creditworthiness of the borrower. A company can withdraw funds up to its established borrowing limit.

    2. Interest on running balance

    In contrast with other traditional debt financing methods such as loans, the interest charged is only on the running balance of the cash credit account and not on the total borrowing limit.

    3. Minimum commitment charge

    The short-term loan comes with a minimum charge for establishing the loan account regardless of whether the borrower utilizes the available credit. For example, banks typically include a clause that requires the borrower to pay a minimum amount of interest on a predetermined amount or the amount withdrawn, whichever is higher.

    4. Collateral security

    The credit is often secured using stocks, fixed assets, or property as collateral.

    5. Credit period

    Cash credit is typically given for a maximum period of 12 months, after which the drawing power is re-evaluated.

    Example of Cash Credit

    Company A is a phone manufacturer and operates a factory where the company invests money to purchase raw materials to convert them into finished goods. However, the finished goods inventory is not immediately sold. The company’s capital is stuck in the form of inventory. In order for Company A to meet its expenses while waiting for their finished goods inventory to convert into cash, the company takes a cash credit loan to run their business without a shortfall.

    Advantages of Cash Credit

    1. Source of working capital financing
    A cash credit is an important source of working capital financing, as the company need not worry about liquidity issues.

    2. Easy arrangement
    It can be easily arranged by a bank, provided that collateral security is available to be pledged and the realizable value of such is easily determined.

    3. Flexibility
    Withdrawals on a cash credit account can be made many times, up to the borrowing limit, and deposits of excess cash into the account lowers the burden of interest that a company faces.

    4. Tax-deductible
    Interest payments made are tax-deductible and, thus, reduce the overall tax burden on the company.

    5. Interest charged
    A cash credit reduces the financing cost of the borrower, as the interest charged is only on the utilized amount or minimum commitment charge.

    Disadvantages

    1. High rate of interest
    The interest rate charged by a loan on cash credit is very high as compared to traditional loans.

    2. Minimum commitment charges
    A minimum commitment charge is imposed on the borrower regardless of whether the company utilizes its cash credit or not.

    3. Difficulty in securing
    The short-term loan is extended to the borrower depending on the borrower’s turnover, accounts receivable balance, expected performance, and collateral security offered. Therefore, it can be difficult for new companies to obtain.

    4. Temporary source of finance
    The loan is a short-term source of financing. A company cannot rely on it for an extended period of time. After the expiration of the loan, it must be renewed under new terms and conditions.


    Difference Between Overdraft (OD) and Cash Credit (CC)


    Cash Credit AccountOverdraft Account
    It is normally given on security of stock, debtors etc.It is normally given on security of a fixed asset.
    The maximum amount is calculated as a percentage of sale and stock along with financial statements. For eg A bank allowed cash credit upto 80% of stock plus 20% of sales.The maximum amount allowed is calculated mainly on basis of financial statements and security.
    It should be used for the purpose of business.Can be used for any purpose.
    Balance Sheet, P & L account , VAT reports is required be submitted to bank generally annually or quarterly.Financial statements are generally not required to be resubmitted after approval.
    Insurance of stock is normally required.Insurance of the property is generally required.
    Many a times new account has to be opened to take cash credit facility.Overdraft is generally started by banks in existing current accounts.
    Interest rate is normally lower than overdraft account.Interest rate is normally higher than cash credit account.

    A businessman has two options while taking a loan for his business. Either to opt for long term funding like LAP (Loan against property) or to go for flexible funding like Cash Credit (CC) or Overdraft (OD). Long term funding generally carries a lower rate of interest while flexible funding gives opportunity to save interest by depositing extra funds in the account and thus paying interest only for amount needed.

    What Is OD Account?

    OD account stands for Overdraft account. It is a type of account in which you can withdraw amount even if there is no fund in your account. The bank sanctions a specific limit and your account can go in negative up to that limit. You have to pay interest only on the amount taken as loan. Since it is a current account, you can make as many transaction as you want. You have to pay interest on the amount which is due by the end of the day.

    Differences between Cash Credit and Overdraft Account

    Overdraft and Cash Credit account both are the type of loan accounts in which the account holder can withdraw the amount he requires . These generally are considered as similar type of loan by many, yet there are some differences between them.

    Points to be considered while taking a CC or OD account facility

    1. Rate of Interest – Rate of interest is higher than fixed loans like Loan against property (LAP) therefore if you generally don’t have extra money to park in cc or od account then you should opt for LAP.

    2. Processing fees – Processing fees charged by bank is normally .5% to .75% and could bargain on it.

    3. Minimum usage condition – Some bank levies charges if the cc or od account is not utilized upto a certain limit. For example you take an OD account of Rs. 10 lakhs and average use during the year is not 30% i.e Rs. 3 lakh then charges are levied.

    4. Account closing charges – Some banks also levies a percentage of loan amount as charges called foreclosure charges if you want to close the account. This generally ranges from 1% to 2%. If your bank levies 2% foreclosure charges then its not beneficial for you to shift to other bank even if other bank gives you a better interest rate.

    5. Interest Servicing – Some banks required the customers to deposit the interest of the month in the account through cash or cheque deposit within a few days of the next month.

    The charges levied by bank is huge if you don’ t fulfill the conditions 3 and 5 above. So you should check the conditions and charges with your bank before opening a new account.