Cash Credit is short-term funding or loan for a company to meet its working capital requirements. Bank offers loans to an enterprise depending on its credit history and financial stability. Funding procured from cash credit loans can be used for various business purposes, such as business expansion, buying plant and machinery, purchasing raw materials, enhancing stocks, hiring staff, paying-off salaries, undertaking training, debt consolidation, etc. Cash credit has a loan repayment tenure of a maximum of up to 12 months that can be renewed.
What is Cash Credit?
Cash Credit (CC) is a short-term loan facility banks provide to businesses, financial institutions, and companies to meet their working capital needs. It allows organisations to withdraw funds even without a credit balance, up to a predefined borrowing limit set by the bank.
Understanding Cash Credit
- Purpose: Designed to finance the instant cash requirements of businesses, such as purchasing current assets or managing daily operations.
- Loan Limit: Varies among commercial banks and is determined based on the business’s creditworthiness and collateral.
- Interest: Charged only on the amount utilised from the approved borrowing limit, calculated daily on the closing balance.
- Repayment Tenure: Typically restricted to 12 months or less.
Key Features of Cash Credit
- Short-Term Finance: Ideal for meeting temporary working capital requirements.
- Collateral Requirement: A secured loan where businesses need to pledge assets like inventory, receivables, or other movable assets.
- Borrowing Limit: Sanctioned by banks in advance based on business turnover, vintage, and creditworthiness.
- Loan Account: Requires creating a separate loan account, unlike overdrafts.
- Flexible Usage: Funds can be withdrawn as needed, thereby giving flexibility in the management of liquidity.
- Interest Charges: Applicable on the withdrawn amount, not on the total credit limit.
Limitations of Cash Credit
- Collateral Requirement: Cash credit is not suitable for firms that cannot pledge assets.
- Strict Evaluation: Cash credit requires detailed financial statement and strong creditworthiness.
- Commitment Charges: Some banks charge some fees for opening and maintaining the loan account.
- Short Tenure: Repayment is normally required within 12 months which is not suitable for long term requirements.
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 its finished goods inventory to convert into cash, the company takes a cash credit loan to run its business without a shortfall.
FAQs
Advantages of Cash Credit?
- Flexibility: The businesses have the liberty of withdrawing funds as needed so that the liquidity can be dealt with properly and efficiently.
- Cost Efficiency: Only the used amount is charged on interest and the entire credit limit.
- Liquidity Management: Ensures that businesses have immediate access to cash when needed.
- Lower Interest Rates: Generally more affordable than overdraft facilities.
- Collateral-Based Security: Provides a sense of assurance to the bank, leading to better terms for borrowers.