Cash Credit vs Trade Credit: Tabular Comparison and Examples
Understanding the difference between cash credit and trade credit is vital for commerce students. These two concepts help businesses manage short-term finance for day-to-day operations. Knowing when and how to use each type supports school exam success, competitive exam preparation, and business decision-making.
| Basis | Cash Credit | Trade Credit |
|---|---|---|
| Provider | Commercial bank or financial institution | Supplier or vendor |
| Interest | Charged on utilized amount | Generally interest-free |
| Security/Collateral | Generally required | Not required |
| Term/Duration | Short-term, usually up to 12 months | 30, 60, or 90 days (as per invoice) |
| Purpose | Meets working capital needs (cash flow, operating expenses) | Allows purchase of goods/services on credit |
| Parties Involved | Business & bank | Buyer & supplier (B2B) |
| Example | Bank grants company a ₹10 lakh cash credit limit secured by inventory | Supplier delivers raw materials with payment after 60 days |
What is Cash Credit?
Cash credit is a bank-provided short-term loan facility. Businesses access it for urgent funds, mainly to finance working capital like raw materials and inventory. Cash credit is not given in cash; rather, it allows withdrawals up to a certain limit as required. Interest is charged only on the amount utilized, not on the entire limit.
Features of Cash Credit
- Provided by banks and financial institutions
- Requires security, usually in the form of inventory or receivables
- Interest charged on daily drawn balance
- Flexible withdrawals and deposits within the sanctioned limit
- Short-term duration, typically less than one year
For example, if a business has a cash credit limit of ₹10 lakh but uses only ₹3 lakh, interest is paid on ₹3 lakh only. At Vedantu, we help students grasp such bank product concepts for exams and daily business scenarios.
What is Trade Credit?
Trade credit is a credit arrangement between a buyer and a supplier where payment for goods or services is delayed. The buyer receives goods now and agrees to pay the supplier after an agreed period. This credit is common in business-to-business transactions and does not involve direct cash lending.
Features of Trade Credit
- Provided by suppliers to buyers
- Generally interest-free for the credit period
- No collateral security required
- Duration based on supplier terms, usually 30-90 days
- Improves buyer’s liquidity, helps continue operations smoothly
For example, a retailer might receive electronics stock from a wholesaler with payment due after 60 days. Trade credit is based on the relationship, trust, and past payment history between the two parties.
Key Differences Between Cash Credit and Trade Credit
The main difference between cash credit and trade credit is in the source, security, and cost. Cash credit involves borrowing money from banks against security, with interest on the utilized amount. Trade credit comes from suppliers, is usually interest-free, and does not require collateral. Both are vital for managing business operations effectively.
When to Use Cash Credit or Trade Credit
A business generally uses cash credit when it needs cash for expenses, covering working capital gaps, and doesn’t have enough supplier support. Trade credit is best for delayed payments on purchases, especially when the supplier extends credit as part of their sales terms.
- Use cash credit to pay wages, utilities, and to buy inventory urgently.
- Use trade credit to buy goods or raw materials from suppliers with deferred payment terms.
Often, businesses use both types of credit side by side—trade credit for supplier payments, and cash credit for other operational expenses. Understanding effective use helps in financial management and exam case studies.
Cash Credit and Trade Credit in Business Practice
In daily business, cash credit supports company liquidity when supplier credit is not enough or when quick cash is needed. Trade credit strengthens supplier–customer relations, helps during tight cash flows, and is a practical alternative to short-term loans. Both reflect on financial statements, affect current assets, and are part of working capital planning. For more on their effect on ratios, see Ratio Analysis.
Summary
To conclude, knowing the difference between cash credit and trade credit is vital for commerce and accountancy exams. Cash credit is bank-based, needs security, and carries interest. Trade credit comes from suppliers, involves no interest, and builds business relationships. At Vedantu, we focus on clear concepts and real-world examples to help students prepare better for exams and business life.
FAQs on Difference Between Cash Credit and Trade Credit
1. What is the main difference between cash credit and trade credit?
The primary difference between cash credit and trade credit lies in the source and terms. Cash credit is a short-term loan from a bank, requiring collateral and attracting interest, while trade credit is a deferred payment from a supplier, often interest-free, built into the business-to-business (B2B) relationship.
2. What is cash credit?
Cash credit is a short-term loan facility offered by banks to businesses. It's a revolving credit line where businesses can borrow up to a pre-approved limit. Key features include:
• Requires collateral (security)
• Charges interest on the amount utilized
• Useful for managing working capital needs.
3. What is trade credit?
Trade credit is a form of short-term financing where a seller allows a buyer to purchase goods or services on credit without immediate payment. It’s a common practice in business-to-business (B2B) transactions. Key aspects include:
• Usually interest-free, but late payments may incur penalties.
• Improves supplier relationships and cash flow for buyers.
• Commonly used for supplier financing.
4. Does cash credit require collateral or security?
Yes, cash credit typically requires collateral, which could be assets like property, equipment, or inventory, to secure the loan. This collateral acts as security for the bank.
5. Is interest charged on trade credit?
Typically, no interest is explicitly charged on trade credit. However, late payments may result in penalties or damage to the supplier-buyer relationship. The implicit cost is the opportunity cost of not investing the funds elsewhere.
6. Where would a business use trade credit instead of cash credit?
Businesses might prefer trade credit when dealing with trusted suppliers, needing short-term financing for inventory, or seeking to maintain strong supplier relationships. It avoids the need for collateral and interest payments, but carries the risk of impacting credit rating if payments are delayed.
7. Can an individual apply for trade credit or is it only business-to-business?
Trade credit is primarily used in business-to-business (B2B) transactions. While some individual consumers might receive credit from retailers, it's not the typical use case. It's largely focused on facilitating transactions between businesses.
8. What is the difference between a cash and credit trade account?
A cash trade account involves immediate payment for goods/services. A credit trade account allows for purchases on credit, with payment deferred as per agreed terms. The key difference is the timing of payment: immediate vs. delayed.
9. What is the difference between cash trading and credit trading?
Cash trading involves immediate payment for goods or services. Credit trading means purchases are made on credit with payment at a later date, allowing businesses to manage cash flow, but carrying the risk of penalties for late payment. The core distinction is the timing of payment.
10. What is the difference between LC and LOC?
An LC (Letter of Credit) is a payment mechanism used in international trade, guaranteeing payment to the seller once specified conditions are met. An LOC (Line of Credit) is a pre-approved borrowing limit, like cash credit, provided by a bank. The main difference is in their purpose: payment guarantee versus borrowing facility.
11. Why do banks charge interest only on the utilized amount in cash credit?
Banks charge interest only on the utilized portion of cash credit because it's a revolving credit line. You only pay for what you borrow. This makes it flexible and cost-effective compared to a fixed-term loan where interest is calculated on the entire loan amount.
12. What risks do suppliers face with trade credit?
Suppliers offering trade credit face risks of non-payment or delayed payments from buyers. This can negatively affect cash flow and profitability. Credit checks and robust credit policies are necessary to mitigate these risks. The risk increases with the length of the credit period given.
