Comparison Table: Cash Credit vs Overdraft with Definitions and Examples
Cash credit and overdraft are important short-term bank facilities used in business and personal finance. Understanding the difference between cash credit and overdraft is crucial for success in school exams, competitive banking tests, and in real-world business management. This topic is frequently covered in Accountancy, Business Studies, and practical banking scenarios.
| Basis of Difference | Cash Credit | Overdraft |
|---|---|---|
| Definition | Short-term loan for businesses to meet working capital needs; taken through a separate cash credit account. | Facility allowing account holders (business or individual) to withdraw more than the account balance up to a limit. |
| Purpose | For regular business operations and maintaining working capital. | To meet short-term financial requirements or temporary cash shortages. |
| Eligibility | Primarily available to businesses and firms. | Available to individuals and businesses, often based on banking relationship or collateral. |
| Account Requirement | Requires opening a separate cash credit account. | Usually provided in an existing current or savings account. |
| Interest Calculation | Charged on the entire amount withdrawn from the limit. | Charged only on the amount actually overdrawn/utilized. |
| Rate of Interest | Generally lower than overdraft. | Usually higher than cash credit. |
| Security | Secured against inventory, receivables, or other business assets. | Secured against fixed deposits, property, salary, or sometimes unsecured for premium clients. |
| Duration | Usually sanctioned for one year; renewable. | Short duration; repayable on demand or renewed monthly/quarterly. |
Difference Between Cash Credit and Overdraft
The difference between cash credit and overdraft is mainly in their purpose, eligibility, account requirement, and interest calculation. Cash credit is best suited for business working capital needs, while overdraft offers flexibility for both individuals and businesses facing short-term cash flow gaps. Both are vital banking products for financial management.
Cash Credit Facility: Meaning and Examples
Cash credit is a short-term loan facility provided by banks to businesses to help meet daily operational expenses. The limit is fixed based on business needs and secured against current assets, such as inventory and receivables. Repayments are flexible, and the cash credit limit can be used multiple times.
Example of Cash Credit
- A manufacturing company avails a cash credit limit of ₹10 lakhs from SBI, secured by its stock and debtors, for working capital.
- This limit allows withdrawals and repayments multiple times within the sanctioned period, usually one year.
Overdraft Facility: Meaning and Examples
Overdraft is a short-term credit facility whereby individuals or businesses can withdraw more than their actual balance. It is provided on current or savings accounts and is generally secured by collateral, like fixed deposits, property, or sometimes even salary for salaried customers.
Example of Overdraft
- An individual maintains a salary account with HDFC Bank. The bank offers an overdraft of ₹1 lakh, secured by a fixed deposit.
- If the person’s account has ₹5,000 but needs to pay a bill of ₹20,000, the overdraft allows withdrawal up to the sanctioned limit.
Key Points: Cash Credit vs Overdraft for Students
- Cash credit requires opening a new account; overdraft works on an existing account.
- Cash credit is mainly for business; overdraft can be for both business and personal use.
- Interest on cash credit is charged on the whole withdrawn amount; overdraft interest is on the actual amount used.
- Overdraft is usually costlier in terms of interest than cash credit.
- Both are vital for short-term fund requirements but serve slightly different needs.
Practical Applications and Usage
Businesses use cash credit for managing working capital and running daily operations. Overdraft helps both businesses and individuals manage unexpected payments, pending cheques, or temporary liquidity shortages. Both facilities teach key financial strategies tested in board exams, bank exams, and real markets.
When to Use Each Facility?
- Choose cash credit for sustained working capital needs in business operations.
- Opt for overdraft for short-term cash gaps—like paying an urgent bill or cheque when the bank balance is low.
Understanding differences between these two can also assist in answering questions in competitive exams like CA Foundation and Working Capital topics, or analyzing financial statements where cash credit/overdraft appear as current liabilities. Explore more on Types of Accounts, Features of Commercial Banks, and Ratio Analysis to deepen your knowledge. At Vedantu, we simplify commerce concepts to help you excel in academics and everyday finance.
In summary, the difference between cash credit and overdraft is important for students in commerce. Cash credit supports business working capital using a separate account, while overdraft helps both individuals and businesses cover temporary shortfalls in existing accounts. Knowing when and how to use each facility enhances financial management skills and exam readiness.
FAQs on Difference Between Cash Credit and Overdraft Explained for Students
1. What is the main difference between cash credit and overdraft?
Cash credit and overdraft are both short-term bank loan facilities, but differ significantly. Cash credit requires a separate account and is typically used by businesses for working capital, while an overdraft allows withdrawals exceeding the account balance, often secured against existing assets or credit history. Key differences include account type, eligibility criteria, and interest calculation methods.
2. What is cash credit?
Cash credit is a short-term loan facility provided by banks to businesses. It involves a separate account where the borrower can withdraw funds up to a pre-approved limit. The interest is calculated only on the amount actually utilized. It's commonly used for managing working capital needs.
3. What is an overdraft?
An overdraft lets individuals or businesses withdraw funds exceeding their available balance in a current account. It's usually granted against security or a strong banking relationship. Interest is typically charged on the outstanding overdrawn amount. It’s a flexible way to manage short-term cash flow needs.
4. What’s the difference between overdraft and credit?
An overdraft is a short-term facility within an existing account, allowing you to overdraw up to a specified limit. A credit usually refers to a broader term encompassing various borrowing arrangements, including credit cards, personal loans, or lines of credit, which may be separate from a checking or savings account.
5. What is the difference between CA and OD?
CA refers to a current account, a type of bank account used by businesses and individuals for day-to-day transactions. An OD (overdraft) is a facility linked to a current account that allows you to withdraw more money than is currently in the account. The overdraft limit is pre-approved by the bank.
6. Who is eligible for cash credit and overdraft accounts?
Eligibility for cash credit and overdrafts varies by bank but generally requires a good credit history and sufficient collateral (security) or a strong banking relationship. Businesses often need to demonstrate financial stability and a clear need for working capital. Individuals may need to meet specific income and credit score requirements.
7. How is interest calculated on a cash credit facility?
Interest on a cash credit facility is calculated on the daily outstanding balance. The bank calculates the interest based on the amount borrowed each day, and this is added to the principal amount, creating a compounding effect. The interest rate depends on several factors such as creditworthiness and prevailing market rates.
8. Can individuals avail cash credit, or is it only for businesses?
While cash credit is primarily used by businesses for working capital management, some banks may offer similar facilities to high-net-worth individuals under specific conditions. However, it's more commonly associated with business needs.
9. What security is required for availing overdraft or cash credit?
The security required for overdrafts and cash credits depends on the bank and the amount borrowed. Common forms of security include fixed deposits, property, or other assets. The bank assesses the risk and may require collateral to mitigate potential losses. The relationship with the bank also plays a crucial role in approving these facilities.
10. What happens if you exceed the overdraft limit?
Exceeding your overdraft limit can result in significant penalties and charges from the bank. You might face high interest rates on the excess amount, and your credit score could be negatively impacted. In severe cases, the bank may take legal action to recover the outstanding debt.
11. What is the difference between cash credit and overdraft with example sbi?
Both SBI (State Bank of India) and other banks offer cash credit and overdraft facilities. The core difference remains: cash credit involves a separate account and is primarily for business working capital, while an overdraft is linked to an existing account and can be used by individuals and businesses for short-term needs. For example, SBI may offer a cash credit against a warehouse receipt and an overdraft against a savings account.
