What are the similarities and differences between a cash credit and an overdraft?

Choosing between credit score and overdraft can be confusing when looking for short terms capital needs. While cash credit is limited only for short-term purposes however this is not the case with an overdraft.

What’s the difference between cash credit and overdraft?

Every business owner needs to take loans to ensure their business runs smoothly. The business owner has two options when it comes to loans:

• Long-term loans like a line of credit and a business loan.
• Short-term loans like cash credit and overdraft (OD).

Today, we will talk about the short-term options and understand which option is better suited for their requirements.

What is Cash Credit?

Cash credit (CC) is a short-term loan offered to business owners (and self-employed professionals) to help them meet working capital requirements. It is different from other loans you take from the bank - you can use this loan only for business-related expenses. 

You need a separate bank account to receive cash credit. It will not be credited to your personal account. You can use the cash credit for a single transaction or multiple transactions - the usage is completely up to you. In most cases, CC is given when you put collateral and pay the loan amount as per the agreed terms - daily or weekly.

Also Read: Do You Know The Pros And Cons of Taking A Business Loan

What is Overdraft?

Assuming you already have a badon'tcount, and your account balance is low. However, you need money to run your business. This is where overdraft comes to the rescue. 

You don't take a loan, but you get an option to withdraw money from an account even if the balance is low. You must know that the overdraft facility is extended only to specific customers by the bank. Mostly, it is offered to customers that have a good financial statement and maintain a good relationship with a bank. The overdraft charge varies from bank to bank.

Similarities between Cash Credit and Overdraft

Below are the similarities between the two:

• Both are financial tools that help businesses borrow money from the bank against their inventory or give collateral.
• Both of these are short-term loan options.
• The interest rate is charged on the amount used by the customers and not on the amount requested for the loan.
• The loan limit and loan amount sanctioned remains fixed, and additional money cannot be withdrawn in both cases.

Difference between Cash Credit and Overdraft

At a high level, both these options look the same, but there are some major differences:

• In CC, the interest rate is lower compared to Overdraft (OD).
• The cash credit limit is decided based on your inventory and stocks. While OD amount is decided based on your credit history, your other investments in the bank, and your relationship with the bank.
• The amount received from cash credit can be used only for business purposes. The OD amount can be used for other expenses as well.
• Cash credit is available to every business owner, while OD is available only to a selected few customers.
• CC's credit tenure is generally one year, while OD duration can be monthly, quarterly, or yearly.
• Also Read: Credit Cards 101: Everything You Need To Know 

Which option to choose?

It depends on one's personal requirements. However, one should prefer cash credit as the interest rate is lower. But if you need cash immediately, you may have to go with an overdraft. If you want funds for a purpose other than business, an overdraft is the only choice for you. You must understand your requirements well, and based on your needs choose the right option. Also, understand that your credit score doesn't play an important role in making a decision as to whether you will get a cash credit or an overdraft.

Conclusion

Before you opt for either option, read the fine prints in the agreement. Don't forget to check the processing fee, interest rate, and foreclosure charges from the bank.