A business without liquidity is like a car without fuel; it may look promising but won’t get far. Liquidity is the cornerstone of financial health, representing a company’s ability to meet its short-term obligations, ensure smooth operations, and safeguard its reputation in the market. Achieving liquidity is often a balancing act for businesses, especially when they face unexpected expenses or delays in receivables.
While there are multiple ways to ensure liquidity, cash credit is one of the most effective tools. In this blog post, we answer the question – what is cash credit? We also discuss its features and importance to business growth and compare it to overdrafts, another liquidity tool.
What is Cash Credit?
Cash credit is a financial instrument to bolster a company’s working capital. It’s a lifeline banks extend, allowing businesses to withdraw money beyond their account balance up to a predefined borrowing limit.
Understanding the cash credit meaning is crucial for businesses to ensure liquidity. Imagine a scenario where a retail business gearing up for the festive season needs to stock up on inventory. While they anticipate robust sales, they lack the funds to make bulk purchases.
Here’s where cash credit comes into play. By availing it, the retailer can procure the necessary inventory, and as sales roll in, they can repay the borrowed amount. This ensures businesses can operate seamlessly, even when faced with cash flow mismatches.
Difference between Cash Credit and Overdraft
While both cash credit and overdraft are forms of short-term financing, they have distinct characteristics. Understanding the distinction between the two can help you make an informed choice for your business’s financial health.
1. Security: Cash credit typically requires collateral, such as stocks, fixed assets, or property. In contrast, overdrafts might not always need collateral and can be based on the relationship between the bank and the customer.
2. Interest: With cash credit, interest is charged only on the amount borrowed, not the entire borrowing limit. Overdrafts, however, might charge a fee for each transaction exceeding the account balance.
3. Duration: Cash credit is typically provided for 12 months, while overdraft terms vary.
4. Purpose: Cash credit is primarily used by businesses to meet working capital needs, whereas overdrafts can be used by individuals and companies alike to prevent checks from bouncing or debit cards from being declined.
Features of Cash Credit
Cash credit comes with several unique features that differ from other borrowing tools offered by financial institutions. These features define the cash credit account meaning and how it operates:
1. Borrowing Limit
Determined by the borrower’s creditworthiness, it’s the maximum amount a company can borrow. The borrowing limit can also be influenced by factors such as the borrower’s past track record, the funds they request, their repayment capacity, the business organisation’s current assets and liabilities, and the collateral or security against the cash credit facility.
2. Interest on Running Balance
Unlike traditional loans, interest is charged only on the running balance of the cash credit account, not the entire borrowing limit. This means businesses only pay for what they use, making it a cost-effective solution.
3. Collateral Security
Cash credit is often secured using assets like stocks or property. This collateral ensures that the bank has a form of security, making it a type of secured loan.
4. Credit Period
Cash credit is usually given for 12 months, after which the borrowing limit may be re-evaluated. However, this period can sometimes be determined every quarter, depending on the agreement between the borrower and the bank.
5. Flexibility
Companies can make multiple withdrawals up to their borrowing limit. This flexibility ensures businesses can access funds as needed, without any restrictions.
The Role of Cash Credit in Business Growth
Cash credit meaning can be summarised as the lifeline of any business to ensure they have the funds to meet immediate needs. For instance, a phone manufacturer might have capital tied up in inventory. While waiting for these goods to sell, they can use cash credit to continue operations without financial hiccups.
Cash credit provides businesses with several advantages:
1. Source of Working Capital
It addresses liquidity challenges, ensuring businesses can meet day-to-day expenses. This is especially crucial for companies with capital tied up in assets or inventory.
2. Flexibility
One of the standout features of cash credit is its inherent flexibility. Unlike traditional loans that have a fixed repayment structure, cash credit empowers businesses with the freedom to withdraw and deposit funds as and when required.
This dynamic approach to financing allows businesses to optimise interest costs effectively. Instead of being burdened with interest on a lump sum amount, companies have the advantage of paying interest only on the actual amount they’ve utilised.
This means if a company only draws half of its available limit, it’s only charged interest on that half, not on the entire borrowing limit. This flexibility not only aids in efficient cash flow management but also ensures cost-effective financing.
3. Tax Benefits
Cash credit offers a dual advantage. While it provides the necessary funds for operations, the interest payments on the borrowed amount are tax-deductible. This provision can significantly reduce a company’s overall tax liability, enhancing profitability and better financial health.
4. Easy Access to Funds
Cash credit offers businesses almost instantaneous access to funds. Whether it’s an unforeseen operational expense, a lucrative business opportunity, or the need to replenish inventory on short notice, cash credit ensures businesses aren’t stranded.
With minimal processing times and a pre-approved limit, businesses can confidently address their immediate financial needs, ensuring continuity and stability.
Final Thoughts
Now, you understand ‘what is cash credit’ and know that it allows businesses to bridge the gap between their current needs and future aspirations. As businesses navigate the ebbs and flows of the market, having a reliable financial instrument like cash credit can be the difference between stagnation and growth. Companies can sustain and thrive in competitive landscapes by comprehending its nuances and harnessing its potential.
Tata Capital Business Loans offer a comprehensive solution for businesses looking to amplify their growth trajectory further. These loans are tailored to meet diverse business needs and provide the financial backing necessary to turn visions into reality.
To elevate your business to new heights, apply for a business loan with Tata Capital today!
09 September 2024
6 mins read
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