Table of Contents
What is Cash Credit?
Cash credit is a facility to withdraw money from a current bank account without having credit balance but limited to the extent of borrowing limit which is fixed by the commercial bank. The interest on this facility is charged on the running balance and not the borrowing limit which is given by bank.
This is a very common facility by banks. It is one of the important short term sources of finance for a business. The availability is also not very difficult.
Important Features of Cash Credit Facility
Cash credit facility is bound by a limit specified by bank. The borrowing limit is determined based on the drawing power of the borrower. Drawing power is calculated using book debts, inventories and creditors. Till this limit is not exhausted, the borrower can withdraw and deposit funds any no. of times.
Interest on Running Balance
Unlike other types of debt financing products of banks like loans, the interest is charged on the running balance of the cash credit current account and not on the sanctioned amount. It is a tremendous motivation for the borrower to collect money from the debtors as soon as possible and deposit in the current account. It is as good as investing the surplus funds at the interest rate which he pays on the cash credit limit.
Minimum Commitment Charge
Normally, a bank would wish some amount of interest to flow in whether a cash credit account is utilized or not. It’s very obvious from bank’s point of view as it is blocking some amount of its ‘float’ for the borrower. For example, in a 10 million cash credit limit, 2 million may be the minimum usage level below which there would be no interest waiver. If the balance goes to 1 million, interest will be calculated on 2 millions only.
A cash credit facility is extended against a security. Securities may be in the form of stock, debtors, etc as primary security and fixed assets and other immovable properties etc as collateral security.
Validity of Credit Period
The limit allowed is valid for say 1 year and then the drawing power will be re-evaluated. One year is just an example whereas in some cases, it may be evaluated every quarter.
Benefits of Cash Credit
The most important benefit of cash credit is its flexibility of deposit and withdrawals. Due to this, a borrower can save a lot of interest cost by depositing the extra cash available with him. It also keeps the borrower motivated towards collection from debtors which will not only expedite the cash cycle but also bring a disciplinary effect on the debtors and borrower himself.
Disadvantages of Cash Credit
The primary disadvantage is that securities required should be adequate and the adequacy is evaluated time and again which increases administrative work for the business.