Cash credit is the line of credit that allows company to borrow money from the bank without credit balance. The company will not be able to receive more than the borrowing limit set by the bank. It is the short term source of finance for the company, and the interest will be calculated by the floating balance, not the borrowing limit.
Feature of Cash Credit:
This is the maximum amount set by the bank, and it is different from one company to another due to the creditworthiness of them. The company can withdraw the fund up to this limit. There is no limit on the number of times that we withdraw money. Moreover, the company can settle anytime they want.
Interest on Running Balance
The company will require to pay the interest on the amount to withdraw only, not the whole amount in the borrowing limit. It is a huge advantage for the borrower to use this kind of credit source if we compare it to the traditional loan.
It is the minimum balance which borrower needs to pay even they do not use the credit balance. It is the fee that bank needs to charge as they have to block the money for company, so they lose the opportunity cost of lending it to someone else.
Bank require company to have colleterial as the security for amount lend to company. Colleterial security can be the fixed deposit, fixed asset, or the stock.
Due to the nature of cash credit, banks allow the company to borrow for 12 months as the maximum period. If company need a longer period, they should consider long term loans or bonds. However, we can request a bank for revaluation credit cash balance in order to extended the period.
Advantages of Cash Credit
- Source of finance: It such a good source of finance for the company that need short term cash flow.
- Flexibility: The company will be able to manage this loan due to its flexibility such as withdraw and paid off.
- Tax-Deductible: Similar to other kinds of loan, company will be able to claim the interest expense as the tax deductale expense.
- Interest Charge: Company can save on interest by withdrawing at the right time and payback when they have sufficient cash.
Disadvantages of Cash Credit
- High-interest rate: The credit cash usually has a high interest if we compare to other traditional loans.
- Temporary only: Using of credit cash only the temporary solution, we cannot replace it with long term loan due to the expensive rate.
- Difficult to obtain: Not everybody can obtain this kind of credit from the bank. Banks usually have strict requirements for company that want to apply for credit cash.
Cash Credit Vs Overdraft
Similar to cash credit, overdraft is a kind of short term loan which bank provide to company on demand. It uses the checking account or another financial instrument as security. For example, company has $ 10,000 in the checking account and withdraws $12,000 to pay for the supplier. The bank will allow the $ 2,000 as a bank overdraft and charge some fee. Company needs to pay interest until the outstanding balance is settled.
Different between Cash Credit and Overdraft:
|Definition||The loan which borrower can withdraw at any time up to the borrowing limit.||The loan which borrowers be able to withdraw after their account balance reaches zero.|
|Duration||Credit cash allows the company to owe money up to 12 months before it is revaluated.||Overdraft usually requires the company payback with a short term like 1-3 months depending on the agreement.|
|Withdrawal||Cash credit allows the borrower to withdraw at any time.||Overdraft only allows the borrower to withdraw when their account balance reaches zero.|
|Amount||The maximum withdraws amount is the borrowing limit.||The maximum withdraw is the amount agree between bank and borrower.|