What is Cash Credit: Explore meaning and advantages

A cash credit loan can be used to meet the working capital gap in situations such as the following:

• Purchasing raw materials
• Maintaining inventory
• Paying salaries and rent
• Storage and warehousing
• Financing sales, etc.

Cash credit loans are crucial for companies in a financial crunch that want to meet the working capital gap. Financial institutions like Bajaj Finserv can offer up to Rs. 80 lakh as a corpus amount, which can be used to meet day-to-day requirements, expand operations, and invest in new machinery.

Important features of cash credit

• Revolving credit: Cash credit provides a revolving line of credit that allows businesses to borrow up to a predetermined limit
• Flexible repayment: Borrowers can repay and redraw funds as needed, making it suitable for managing fluctuating cash flow.
• Interest charges: Interest is charged only on the amount borrowed and for the duration of its use, offering cost-effective financing.
• Collateral requirement: Cash credit often requires collateral, such as inventory, accounts receivable, or property, to secure the line of credit.
• Monitoring: Lenders may monitor the borrower's financial performance and require periodic reviews to assess creditworthiness and adjust credit limits accordingly.

Example of a cash credit

A prime example of cash credit is a revolving line of credit provided by a bank to a business. Let's consider a retail store that experiences seasonal fluctuations in sales. During peak seasons, the store may need additional funds to purchase inventory and meet customer demand. With a cash credit facility, the store can borrow funds up to a predetermined limit to purchase inventory. As sales pick up and cash flow improves, the store can repay the borrowed amount. This flexibility allows the business to manage its working capital efficiently, ensuring it has the necessary funds to operate smoothly during both busy and slow periods.

Advantages of cash credit

• Flexibility: Cash credit offers businesses flexibility in borrowing and repaying funds as needed, allowing them to manage cash flow fluctuations effectively.
• Cost-effectiveness: Interest is charged only on the amount borrowed and for the duration of its use, making cash credit a cost-effective financing option.
• Working capital management: Cash credit helps businesses maintain adequate working capital levels to cover operational expenses and seize growth opportunities.
• Collateral utilization: Businesses can use assets such as inventory, accounts receivable, or property as collateral, unlocking their value to secure the line of credit.
• Continuous access: With cash credit, businesses have continuous access to funds, enabling them to address short-term financing needs promptly.

Disadvantages of cash credit

• Interest costs: Cash credit can incur higher interest costs compared to term loans, especially if the borrowed funds are not repaid promptly.
• Collateral requirement: Lenders often require collateral to secure cash credit, which may tie up valuable assets and restrict their use for other purposes.
• Potential for overborrowing: The revolving nature of cash credit can lead to overborrowing if businesses are not careful, resulting in excessive debt and financial strain.
• Monitoring and review: Lenders may impose regular reviews and monitoring of the borrower's financial performance, adding administrative burden and potential restrictions on credit usage.
• Dependency: Businesses may become overly reliant on cash credit, leading to a lack of diversification in financing sources and increased vulnerability to economic downturns or changes in credit conditions.

Principal elements of cash credit

• Credit limit: The maximum amount that can be borrowed under the cash credit facility.
• Interest rate: The rate charged on the borrowed funds, typically based on the prevailing market rates and the borrower's creditworthiness.
• Collateral: Assets pledged to secure the cash credit facility, assuring the lender against default.
• Repayment terms: The terms governing the repayment of borrowed funds, including interest payments and the timeline for repayment.
• Revolving nature: Cash credit offers a revolving line of credit, allowing borrowers to borrow, repay, and redraw funds as needed within the credit limit.
• Monitoring: Lenders may monitor the borrower's financial performance and conduct periodic reviews to assess creditworthiness and adjust credit limits accordingly.

Cash credit vs overdraft

Usually, cash credit and overdraft are considered similar financial products as most of their features overlap. However, there are some points on which these products can be differentiated, as discussed below:

How to avail cash credit?

Here are a few simple steps to secure cash credit:

1. Research and select a financial institution:Explore financial institutions offering cash credit facilities with favourable terms. Assess interest rates, collateral requirements, and credit limits for comparison.
2. Ensure eligibility:Meet bank requirements such as creditworthiness and financial stability. Confirm availability of necessary documentation like identification and income statements.
3. Complete application:Visit the financial institution to request a cash credit application form or start your application online. Fill out the form accurately and submit it along with required documents.
4. Credit assessment and negotiation:The financial institution evaluates your creditworthiness and assesses collateral value. Negotiate terms including credit limit, interest rates, and repayment schedule.
5. Activation and utilisation:Upon approval, the financial institution activates your cash credit facility. Utilise the available credit responsibly for short-term financial needs, ensuring compliance with agreed terms and conditions.

Managing your cash credit facility

Managing your cash credit facility efficiently is crucial for financial stability and growth. Here's how to do it effectively:

1. Strategic utilisation: Use the credit judiciously for short-term needs like inventory restocking or operational expenses to optimise its benefits.
2. Clear repayment plan: Develop a concise repayment strategy to pay off the outstanding balance on time, minimising interest costs and maintaining a healthy credit profile.
3. Regular monitoring: Keep a close eye on your credit utilisation to avoid exceeding the approved limit and incurring unnecessary interest charges.
4. Understanding terms: Familiarise yourself with the terms and conditions of your cash credit facility to ensure compliance with repayment schedules, interest rates, and other obligations.
5. Communication: Maintain open communication with your financial services provider regarding any changes in your financial situation or challenges in meeting repayment obligations, ensuring a mutually beneficial relationship.

How does cash credit help businesses?

Cash credit can help businesses by providing them with flexibility and instant access to funding when they need it most. It can help to alleviate cash flow problems and can also be used for short- and long-term investments.