When companies or start-ups are established, there are a lot of things that they need to consider. One of the most important aspects is finance.
Managing finances is one of the key reasons contributing to the success of the company. But that does not mean things are always positive for the businesses.
They can continuously face financial failures that they need to cope up with. Many financial tools exist that can save a company by offering them short term or long term funds. Two of these processes are overdraft and cash credit.
Overdraft and cash credit are often considered similar funding processes, but there are quite some features that differentiate both these terms which we need to understand.
Overdraft vs Cash Credit
The main difference between overdraft and cash credit is that overdraft allows you to withdraw more money than what is in your bank account while cash credit allows you to withdraw money only up to a certain limit.
Bank overdraft is a loan that can allow you to have a negative balance but that is not the case with cash credit. Cash credit is a loan that can only allow you to withdraw money without making your balance negative. Other differences that exist between overdraft and cash credit is shown in the comparison table below.
Comparison Table Between Overdraft and Cash Credit (in Tabular Form)
| Parameter of Comparison | Overdraft | Cash Credit |
|---|---|---|
| Definition | A loan where the customer is allowed to withdraw money more than the current bank balance. | A loan where the customer is allowed to withdraw money to a certain limit, without making current bank balance to negative. |
| Duration | Only for a shorter period. | It can be extended for a mid-term period. |
| Repayment | It can be repaid any number of times. | It can be repaid in installments. |
| Offered to | Mostly individuals. | Mostly companies, manufacturers, traders, etc. |
| Interest Rate | Comparatively higher. | Comparatively lower. |
| Basis of providing | Financial statements and credit history. | Business situation and market analysis. |
What is Overdraft?
Overdraft is a type of loan where the customer is allowed to withdraw more money than what is already in their bank accounts i.e. it can allow you to have a negative balance.
For example, you have 40$ in your bank account but want to withdraw 45$ to pay for an item, so the bank can pay for those 5$ but will charge you a small service fee.
There are two types of overdraft.
- Standard overdraft
- Secured overdraft
In a standard overdraft, it is the same procedure that you can simply withdraw more money than your bank balance but the bank will charge you a fee for it.
In a secured overdraft, the bank or some financial situation can lend you the money but you are allowed to use the mutual fund shares.
The interest rate for overdraft is typically higher than cash credit. It is granted to borrowers only for a shorter period.
The process of granting an overdraft to the borrower for a specific period is known as overdraft protection. It is provided to individuals in case they are facing some financial activity.
Suppose, you have to pay the rent but your current balance is slightly lower than the rent. If you have overdraft protection, you are saved because your bank can cover for that extra cost.
So depending upon your relationship with the bank, it will have a look at your financial statements and credit history to cover for the costs of overdraft.
What is Cash Credit?
Cash credit is a type of loan where the customer can only withdraw money up to a certain limit without making your bank balance negative.
The interest rate for cash credit is typically lower than the overdraft. It is granted to borrowers for a mid-term period and the borrower can pay the amount back in installments.
Cash credit is mostly for companies, traders, manufacturers, and retailers. Based on their business performance and current market situation, the bank can determine the credibility of the borrowers.
So, for new companies, it can become a little difficult to convince them and obtain cash credit.
For example, a company has invested a huge amount of money into some business deal. But for some reason, the deal gets stuck and so does the money.
If the company wants to purchase something and is now low on cash, it can ask the bank for the favor of cash credit. In this way, the company can run its business without having to worry about its downfall.
Main Differences Between Overdraft and Cash Credit
Some of the features that differentiate between Overdraft and Cash Credit are given below:
- Overdraft is a type of loan where the customer is allowed to withdraw money more than the current bank balance. Cash credit is a type of loan where the customer is allowed to withdraw money to a certain limit, without making the current bank balance to negative.
- The duration for overdraft is only for a shorter period while the duration for cash credit can be extended to a mid-term period.
- An overdraft can be repaid any number of times. Cash credit can be repaid in installments.
- Overdraft is offered to most individuals whereas cash credit is offered to companies, retailers, manufacturers, and traders, etc.
- The interest rate of overdraft is comparatively higher while the interest rate of cash credit is comparatively lower.
- Providing an overdraft to a borrower is based on his financial statements and credit history while providing cash credit to a borrower is based on his business situation and market analysis.
Conclusion
There can come a time in life where you or your business might be facing some difficult situations financially. For these cases, the bank or financial institutions have some policies that can provide relief to these individuals or some companies.
Whether it is an overdraft or cash credit, they can become the temporary sources of finance when your business is facing instability or an individual needs to pay for something necessary.
References
- https://www.sciencedirect.com/science/article/pii/S0304393217300788
- https://academic.oup.com/rfs/article-abstract/27/4/990/1603971