Difference between Cash Credit and Bank Overdraft

In India, Cash Credit (CC) and Bank Overdraft (OD) facilities are the two most common facilities provided by banks. Although they sound similar, both allowing the business to access funds above the current account balance, the purpose and structure can differ significantly as well as the relative cost and suitability of each facility. Understanding the differences can help the business mitigate potential costs and constraints and select the right facility.

What is Cash Credit?

Cash Credit facility is a short-term loan product generally given to businesses to assist in meeting working capital requirements. Under a CC facility, the bank approves the amount of credit, often based on the business’s stock, inventory, receivables, or other current assets being pledged as collateral. The business can utilize that amount up to the credit limit, use it for its operations (buying raw materials, wages, general working capital), and will only pay interest on the amount utilized. According to sources such as HDFC Bank, the facility is provided to businesses for business purposes and not personal purposes.

A Cash Credit facility has the following features:

Typically secured by current assets (e.g., inventory, stock-in-trade, receivables).
The limit is fixed at the time of sanction (subject to a review) based on those assets value and the margin applied by the bank.
Interest is charged only on utilized portions, not the entire sanctioned limit, in most cases.
Tenure is usually one year or more, with the option to renew at the end of the tenure dependent on business conditions.
It is intended to be used for ongoing working capital needs; therefore, it is better for businesses that have expected cash flows and expected ongoing working capital needs.
Interest rates are generally lower than for overdrafts, due to the collateral/security involved.

What is a Bank Overdraft?

A Bank Overdraft facility is essentially a kind of credit facility that is typically linked to a current account (or a business account) that allows the account holder to withdraw cash or make payments despite their bank account balance being below zero, up to a limit as agreed with the bank. It provides flexibility for temporary cash flow issues or emergencies, for example where a business has a transactional account and would like to clear payments but is only waiting for incoming receipts, the overdraft will allow them to engage on these transactions where they would otherwise not be able to due to the timing of cash flows.

Typical Characteristics of an Overdraft facility:

The Overdraft facility can be either secured, if collateral is available, or unsecured, depending on the bank’s policy and the lender’s relationship with the borrower.
Interest is charged on the amount drawn and is often calculated on a daily basis.
The lending limit can move dynamically and will sometimes reduce over time, or vary on current lending policies and commercial conditions, while the bank’s monitoring and review continues.
The tenure is shorter, often monthly, quarterly or up to one year, and the facility is subject to closer scrutiny by the bank, so is often reviewed more often.
Both businesses and individuals can use an overdraft (although the limits and terms differ between the two).
It is often a more flexible facility than credit, and has little or no security.

Side-by-Side Comparison: Cash Credit vs Overdraft

Here is a comparative summary of key differences between Cash Credit (CC) and Overdraft (OD) facilities:

Feature	Cash Credit (CC)	Overdraft (OD)
Purpose	Primarily for business working-capital needs (inventory, raw materials, etc)	For short-term cash flow gaps, can be used for business or personal account linked needs
Security / Collateral	Usually collateral required (inventory, stock, receivables)	May be unsecured or secured depending on borrower and bank relationship
Interest Rate	Typically lower due to collateral backing	Higher owing to higher risk / unsecured nature
Tenure / Review	Generally one year or more, renewable	Shorter tenure, often monthly/quarterly up to 1 year, frequent review
Limit Determination	Based on the value of collateral (stocks, inventory)	Based on account relationship, financials, credit history
Account Setup	Often requires a separate account for the facility	Usually linked to an existing current account
Usage Flexibility	Less flexible in terms of switching uses; geared for business operations	More flexible; can handle unpredictable short-term needs
Rate/Cost for Long Term	More cost-effective if used continuously for working capital	More expensive if used for long periods
Best suited for	Businesses with ongoing working-capital needs and collateral	Businesses or individuals needing occasional funds or flexible access

Which is Better for Your Business?

Determining whether a Cash Credit facility or an Overdraft is better depends a lot on your business’s profile and the purpose for which you will be using the funds.

If your business is predictable in its working-capital needs – for example, a cycle of inventory purchases, raw-material procurement, and wage payments and you feel comfortable pledging collateral, a Cash Credit facility is more economical; it has lower interest rates and a more stable limit than an OD facility. Several references state that a Cash Credit is better suited for needs that are primarily for ongoing operations.

If your business operates in a less stable cash-flow situation, there are random cash-flow mismatches in the short-term, or you only need funds occasionally to bridge cash-flow shortfalls, an Overdraft facility is better suited to your needs, as it will provide you more flexibility. It may also require less documentation and may be offered on an existing current account without requiring you to establish a new account. Many articles note that an OD facility is more suited for needs of this nature!

At the same time, it is important that you do determine whether you are not misusing an OD as a substitute for funding related to an ongoing cash-flow need, because that type of funding is higher in cost (over time) and with a bank establishing limits on ongoing use, and in some cases shrinking limits, an OD facility will not work for any one application over the long run. Further, banks review ODs on a regular basis and can reduce limits even without warning!

Relationship to Business Creditworthiness & Reporting

In acquiring either of these current cash flow facilities, both the business creditworthiness and the business’s financial situation will come under assessment. The lender will of course look at financial statements, look at cash-flow forecasts, assess inventory turnover, debtor days and working-capital cycles. Businesses with a good financial track record can expect reduced terms, higher limits and lower interest rates.

For businesses it’s also beneficial to track and retain a company credit information report, so the bank/creditor can look up your company credit history. Services such as that offered by Kenstone Capital (a Company Credit Information Report in India) assist companies in tracking, managing and presenting their credit profile to lenders. Being transparent can give you leverage when applying for either a CC or OD facility.

Finally, if you already have issues in your credit history or default events, it would be ideal, prior to applying for an OD or CC facility, to rectify these by using the Credit Score Repair Agency service provided by Kenstone Capital or another organisation, so that your overall borrowing costs are minimized and you are looked upon more favourably when applying for credit.

Practical‍‌‍‍‌‍‌‍‍‌ Considerations Before Using the Facility

When making a choice between two; think about the factors that follow:

1. Purpose of Funds

– If the money is to be used for the daily running of the business (e.g., regular purchases, inventory management) then a CC is more reasonable.

– If it is a short-term, temporary gap situation (e.g., waiting for a client to pay, making a temporary purchase) then an OD could be enough.

2. Collateral Availability

– Do you have stock, inventory, receivables, or any other current assets against which you can give a pledge? If so, CC becomes a choice.

– If you don’t have this type of collateral but have a good bank relationship, an OD may be more accessible.

3. Cost and Term

– Look at the interest rate, the processing fees, the renewal or the review terms for both. If you can commit to an annual renewal, a CC usually has a lower cost.

– Do not use OD for a long period of time without caution, because you may be burdened with higher interest and a variable limit.

4. Monitoring and Review

– The limit of a CC usually remains the same for some time and is only reviewed once a year. The limit of an OD may reduce monthly or at frequent intervals depending on usage and bank review.

– Make sure that you fully understand the review criteria, stock statements or usage norms that the bank requires for your facility.

5. Impact on Credit Profile

– If you frequently use the facility, repeat over-utilisation, or frequently make drawdowns may increase the risk that the bank will identify thus resulting in a decrease in your creditworthiness.

– Keeping good records, not going beyond the limit and maintaining a comfortable utilisation of the sanctioned limit will be a positive factor in your business credit history.

6. Combine with Other Financial Tools

– You can also use both facilities simultaneously: an OD to cover sudden unpredictable cash-flow needs and a CC to cover the scheduled working-capital cycle.

– Always ascertain whether it is possible or cost-effective to switch from one facility to another given your business needs that are constantly ‍‌‍‍‌‍‌‍‍‌changing.

Example Scenarios

Scenario‍‌‍‍‌‍‌‍‍‌ A – Manufacturing Company with Regular Inventory Purchases

A tiny manufacturing enterprise buys raw materials every month, changes them into finished products, and then gets money from customers after 45 days. As the company has very stock and inventory cycles, they use inventory as collateral. They take a Cash Credit facility of, say, ₹ 50 lakhs for one year. The rate of interest is low since the bank is assured of collateral and regular operations. They operate up to the limit when required and pay interest only on the amount they have drawn, thus allowing them to carry on with production smoothly.

Scenario B – Service Firm with Occasional Payment Delays

A services company maintains a current account with the bank and is, however, rarely, faced with delays in client payments resulting in short-term cash-flow gaps. They are without large stocks or receivables for pledging. They go for an Overdraft facility of ₹ 10 lakhs linked to their current account. The overdraft is only utilized in case of necessity and interest is paid on the overdrawn amount daily. Given that the facility is more flexible but less secured, the cost is higher; however, it is considered acceptable due to the occasional nature of the need. ‍‌‍‍‌‍‌‍‍‌

Closing Thoughts

Both‍‌‍‍‌‍‌‍‍‌ Cash Credit and Overdraft are excellent banking instruments, but you should not confuse between them. Their effectiveness depends on how well the business’s cash-flow pattern, collateral availability, cost tolerance, and usage frequency are matched.

Where regular working capital requirements are a feature of your business and you are willing to offer collateral, a Cash Credit facility is a better option in terms of cost, stability, and suitability. On the other hand, if your need is sporadic, brief, and you seek flexibility without giving assets as security, then perhaps an Overdraft would be a better choice.

Moreover, always be aware that facility terms are affected by your total creditworthiness, financial discipline, and banking relationship. Using Kenstone Capital’s Company Credit Information Report or Credit Score Repair Agency services can be a great way to increase your bargaining power when you approach banks for these facilities.

It is also a good idea to thoroughly inspect the interest structure, review/renewal terms, collateral monitoring, hidden fees (unutilized charges, foreclosure costs) in the case of rescinding a contract, and check if the facility matches your business’s operational cycle before signing any agreement. When the right decision is made and management is done in a disciplined manner, the facility that you select will be a strategic enabler rather than a financial ‍‌‍‍‌‍‌‍‍‌burden.