Consistent cash inflows help businesses take care of their day-to-day operations. If a company’s working capital needs aren’t met adequately, it could negatively affect its smooth business operations. To bridge this financing gap, cash credit or working capital loan is introduced by the banks. This loan can be availed either in the form of a secured loan or an unsecured loan. A company typically has a running account with a particular lender for a cash credit loan and uses funds from the account whenever the need for working capital arises. Now, let us understand what cash credit is? And how it works?
What is Cash Credit?
Cash credit is short-term financing or loan for a company to fulfill its working capital requirements. The loan can be used for different purposes, including paying the storage area rent, buying raw materials, paying staff wages, etc., and has a tenure of up to 12 months. A company needs to submit collateral or security to avail cash credit loans. The collateral to be submitted can be in the form of raw materials, stock-in-trade, fixed assets, equipment, finished goods, etc. In addition, cash credit allows a company to withdraw money as many times but up to its withdrawal limit.
An attractive feature of a cash credit loan is that the interest rate is charged only on the amount withdrawn, not on the whole borrowed limit. For example, Company A is a chip manufacturer that owns and operates a factory where it spends money to buy raw materials to convert them into finished products. The finished product inventory is not sold right away. In this case, the company’s fund is stuck in the form of inventory. Company A takes a cash credit loan to cover its expenses while waiting for its finished goods inventory to turn into cash.
Spotlight Features of Working Capital loan:
- Cash credit is granted against collateral or security.
- It is given to meet the daily working requirements of a business.
- It can be repaid in the form of monthly, quarterly, or half-yearly repayments.
- Individual applicants can avail cash credit against their fixed deposits and save on interest.
- Interest rate pay off on cash credit loan is tax-deductible
- Money can be withdrawn any number of times from the sanctioned limit.
How does a Cash Credit works?
Cash credit lets a company withdraw money from a bank account that is created by the bank (lender). The company can withdraw a number of times until the total sanctioned limit is reached. The lender determines the cash limit based on the applicant’s profile and creditworthiness. Also, the amount approved is calculated based on the business’ need for cash, current assets and liabilities, creditworthiness, repayment capacity, etc. The amount withdrawn is subject to an interest rate that is evaluated on the given collateral, creditworthiness, and other factors. Moreover, the bank has the right to recall the funds at any moment, and the borrower is expected to repay them immediately. Even if a company does not use any borrowed funds, it must pay a minimum commitment fee to the bank.
Who can avail for Cash Credit?
This loan facility can be availed by business owners, individuals, sole proprietorships, companies, limited liability partnerships (LLPs), partnerships, co-operative societies, and registered trusts engaged in manufacturing, trading and services categorized under MSME.
- A quicker way of dealing with working capital shortages
- The cash credit loan is easily arranged by the bank as long as the loan amount is determined and collateral security is pledged.
- The company gets flexibility in withdrawing credit as many times from the account up to its withdrawal limit.
- The deposit can be made whenever the company has excess funds to lessen the burden of interest.
- Easy arrangement, provided that collateral is available to be pledged.
The expression ‘cash is king’ signifies the importance of cash. Without the proper amount of cash on hand, businesses can run into major trouble and even be forced into bankruptcy. If a company does not have enough funds to meet its working capital needs, it can go for cash credit. If you are facing any financial issues, connect with our experts to find the right solution.