Cash credit: what is it and how does it work?

Banks lend cash loans to businesses based on their creditworthiness, which is determined by their current assets and liabilities.

Access to credit is an essential condition for any business, regardless of its size. Whether paying wages for labor or purchasing raw materials, servicing stored goods or managing the supply chain, businesses are in constant need of credit even when returns are inconsistent. . According to a CRISIL analysis, the difference between current assets and current liabilities of a large number of MSMEs in India has grown steadily since fiscal 2015. It is to fill this working capital gap that businesses have access to short-term financial assistance from banks in the form of cash loans. Available for a period of up to 12 months, the credit cash credit can be withdrawn as many times by the borrower within this period, within the limit of the borrowing limit.

Banks lend cash loans to businesses based on their creditworthiness, which is determined by their current assets and liabilities. The shares and assets of a business such as raw materials, work in progress, finished goods, trading stocks, etc. are used as collateral collateral against which the value of a cash loan is determined. An important feature of a cash flow credit loan is that once it is approved, the interest rate is only applied on the amount withdrawn, and not on the entire borrowed limit. However, companies are required to pay a minimum commitment fee whether they use an amount or not at all.

Advantages and disadvantages of cash loans

A major advantage that the cash credit loan offers businesses is that they do not have to worry about liquidating their inventory and assets to qualify for the loan. However, since these loans are short term (with a maximum term of 12 months), businesses cannot rely on them for an extended period. The term of the cash credit loan can be renewed when it expires but it involves a reassessment of the terms and conditions.

Because of their lower amount than conventional loans, a cash loan can be easily set up by banks after valuation of a company’s assets. But since these loans are guaranteed by businesses on the basis of their proven track record of profit and collateral offered, new businesses find it difficult to avail cash credit loans due to lack of creditworthiness. required.

As stated above, a cash credit loan can be withdrawn multiple times once approved, provided the amount withdrawn is within the borrowed limit. Additionally, since interest only applies to the amount withdrawn (as opposed to the total amount borrowed), businesses can deposit excess funds to ease the interest burden. Another benefit that businesses get from a cash credit loan is that the interest is tax deductible. On the other hand, the interest rate applied to these loans, on the amount withdrawn, is very high. Moreover, even if a company does not use any amount of the borrowed money, it still has to pay a minimum commitment commission.

For small business owners, choosing the best source of credit depends on the purpose for which they wish to obtain credit. Entrepreneurs with a start-up business can take advantage of personal loan products for the self-employed, such as a line of credit ready to borrow money instantly, and without the hassle of cumbersome paperwork.

(By Anuj Kacker, COO and Co-Founder, MoneyTap)

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