Difference between Cash Credit and Overdraft

Cash credit is a short-term cash loan to a company. A bank provides this type of funding, but only after the required security is given to secure the loan. Once a security for repayment has been given, the business that receives the loan can continuously draw from the bank up to a certain specified amount. This type of financing is similar to a line of credit.

Furthermore, cash credit is a facility to withdraw the amount from the business account even though the account may not have enough credit balance. The limit of the amount that can be withdrawn is sanctioned by the bank based on the business cycle of the client and the working capital gap and the drawing power of the client. This drawing power is determined, based on the stock and book debts statements submitted by the borrower at monthly intervals against the security by hypothecating of stock of commodities and/ or book debts. The excess withdrawal of cash is made generally on demand from the customer and the customer has to pay interest on the excess amount he/she has withdrawn. The cash credit facility is quite useful to those businesses where cash payment like wages, transportation, cash purchases are to be made and the receivables are not realized in time.

An overdraft facility is a formal arrangement with a bank which allows an account holder to draw on funds in excess of the amount on deposit. Overdraft facility financing is most commonly used by businesses as a way of making their working capital more flexible, although it can also be available to individuals. Banks which offer this service typically have a number of expectations from customers who use it, and it is important to be aware of these expectations before entering an overdraft facility agreement.

The idea behind overdraft facility agreements is that sometimes one needs a bit more money than is available on deposit to deal with various expenses. For example, a business which is always slow in March and April might like to use its overdraft facility to make payroll and keep current with all accounts and creditors. Or, a business might need to make a big one-time expense which exceeds the funds on deposit. With an overdraft facility, people can repay the funds at their convenience. The bank may charge an overdraft fee for accessing the overdraft facility, and the interest rate can be higher than that for other types of loans. The bank also has the right to demand repayment in full. Balancing an overdraft facility wisely can free up capital and make people more stable financially, but unwise use can lead people into a spiral of debt which may be difficult to escape.

The amount of an overdraft facility is also curbed; people are not allowed to continually take money out and not repay it. The amount of the overdraft is usually pegged to account history and financial information, with the goal of ensuring that people do not end up borrowing more than they can realistically repay through an overdraft facility. The agreed limit can be negotiated with the bank, and some banks are willing to reevaluate if customers feel that their circumstances have changed.

Similar to personal overdraft facilities, a business overdraft is a prearranged spending limit with your bank. Many businesses find an overdraft useful for those times when cash flow is a problem for a short period of time. Overdrafts are not a good option for funding larger needs, such as capital or expansion expenses. For these needs it is less expensive to obtain a separate business loan. Business overdrafts may also be subject to more fees than a personal overdraft. Examples include fees to open the overdraft, to renew the overdraft, or sometimes even a fee for not using the overdraft. When used judiciously, overdraft facilities can be a great help in managing the occasional financial shortfall.

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