Cash credit is the line of credit that allows company to borrow money from the bank without a 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.
Cash credit is a type of short-term loan that can be used for business purposes. The loan is typically repaid within a year, and the interest rate is usually higher than the rate for a standard business loan. There are several benefits to using a cash credit, including the ability to access funds quickly, the flexibility to repay the loan early if desired, and the relatively low cost of borrowing.
This can be useful for businesses that need working capital but don’t want to take out a traditional loan. Cash credits are usually secured by collateral, such as accounts receivable or inventory, and they typically carry higher interest rates than other types of loans.
However, there are also some risks associated with cash credit, so it’s important to carefully consider all options before taking out this type of loan.
Feature of Cash Credit:
This is the maximum amount set by the bank, and it is different from one company to another due to their creditworthiness. 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.
The borrower can repay the debt at any time. Credit limits are usually expressed as a line of credit, which is the maximum amount that can be borrowed at any given time. Most lines of credit have an interest rate and a term, and the borrower must make regular payments to repay the debt.
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 a traditional loan.
A line of credit is a flexible and convenient borrowing option that can be used for a variety of purposes. Unlike a traditional loan, which requires the borrower to repay the entire amount, a line of credit only requires the borrower to pay the interest on the amount withdrawn only. This makes it an ideal borrowing option for those who need access to quick funding but may not necessarily need to borrow the entire amount available. In addition, lines of credit typically have lower interest expenses due to the lower loan balance, making them an even more attractive option for borrowers. As a result, lines of credit are becoming an increasingly popular borrowing option for businesses and individuals.
It is the minimum balance that borrower needs to pay even if they do not use the credit balance. It is the fee that bank needs to charge as they have to block the money for the company, so they lose the opportunity cost of lending it to someone else.
By setting a minimum balance, banks are able to ensure that they are compensated for their opportunity cost. In some cases, the minimum balance may also be used to cover the administrative costs of maintaining the account. For example, if a borrower does not borrow any money, but they still charge the minimum fees as the bank needs to prepare the available balance.
Bank requires the company to have colleterial as the security for the amount lent to the company. Colleterial security can be a fixed deposit, fixed asset, or stock.
The purpose of collateral is to protect the bank’s investment in the event that the borrower is unable to repay the loan. If the company defaults on the loan, the bank can seize the collateral and sell it in order to recoup its losses. For this reason, it is important for companies to carefully consider what type of collateral they will use when taking out a loan from a bank.
Due to the nature of cash credit, banks allow the company to borrow for 12 months as the maximum period. If the company needs a longer period, it should consider long-term loans or bonds. However, we can request a bank for revaluation credit cash balance in order to extend the period. However, if a company needs to borrow for a longer period of time, it should consider other options such as long-term loans or bonds.
Advantages of Cash Credit
- Source of finance: It is such a good source of finance for a company that needs short-term cash flow.
- Flexibility: The company will be able to manage this loan due to its flexibility such as withdrawal and payoff.
- Tax-Deductible: Similar to other kinds of loans, the company will be able to claim the interest expense as the tax deductible expense.
- Interest Charge: Company can save on interest by withdrawing at the right time and paying back when they have sufficient cash.
Disadvantages of Cash Credit
- High-interest rate: The credit cash usually has a high interest if we compare it to other traditional loans.
- Temporary only: Using credit cash is only a temporary solution, we cannot replace it with a long-term loan due to the expensive rate.
- Difficult to obtain: Not everybody can obtain this kind of credit from a bank. Banks usually have strict requirements for companies that want to apply for credit cash.
Cash Credit Vs Overdraft
Similar to cash credit, overdraft is a kind of short-term loan which banks provide to companies 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.|