Cash credit loans can be withdrawn as many times by the borrower within a certain time, up to the borrowing limit.
Access to credit is a critical requirement for any enterprise irrespective of its size. Whether it is to pay labour wages or to buy raw materials, maintenance of stored goods or managing the supply chain, companies are in constant need of credit even when the returns are not consistent. According to a CRISIL analysis, the difference between current assets and current liabilities of a large number of MSMEs in India have constantly been widening since FY2015. It is to bridge this working capital gap that enterprises access short-term financial help from banks in the form of cash credit loans. Available for a tenure of up to 12 months, cash credit loan can be withdrawn as many times by the borrower within that time, up to the borrowing limit.
Banks lend cash credit loans to companies based on their creditworthiness, which is determined by their current assets and liability. A company’s stock and assets like raw materials, work-in-progress, finished goods, stock-in-trade, etc., are used as collateral security against which the value of a cash credit loan is determined. An important feature of a cash credit loan is that once it is approved, the interest rate is charged only on the amount withdrawn, not on the whole borrowed limit. However, companies are required to pay a minimum commitment charge irrespective of whether they use any amount or none at all.
Advantages and disadvantages of cash credit loans
A major perk that cash credit loan offers the enterprises is that they do not need to worry about liquidating their stocks and assets to avail the loan. However, since these loans are short-term (with a tenure of up to 12 months), companies cannot rely on them for an extended period of time. The tenure of the cash credit loan can be renewed once it expires but it involves re-evaluation of the terms and conditions.
On account of them being of a smaller amount than regular loans, a cash credit loan can be easily arranged by the banks after the valuation of a company’s assets. But since these loans are secured by companies based on their proven record of profit and collateral security offered, new enterprises find it difficult to avail cash credit loans due to an absence of required creditworthiness.
As discussed above, a cash credit loan can be withdrawn multiple times once it is approved, as long as the withdrawn amount falls within the borrowed limit. Also, since the interest is only applied to the amount that is withdrawn (as opposed to the total of the borrowed amount), companies can deposit excess funds to mitigate the burden of interest. Another benefit that companies 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. Also, even if a company does not utilise any amount from the borrowed sum, it has to pay a minimum commitment charge nonetheless.
For small business owners, choosing the best source of credit depends on the purpose for which one wants to avail credit. Entrepreneurs with early-stage businesses can benefit from personal loan products for self-employed individuals, such as a ready line of credit to borrow money from instantly, and without the hassles of a cumbersome paperwork.
(By Anuj Kacker, COO & Co-Founder, MoneyTap)