Cash credit is a short-term source of finance provided by banks to businesses for meeting their working capital requirements.
It allows a company to withdraw funds from its account even when the balance is zero, up to a certain limit approved by the bank.
This facility helps businesses manage daily expenses such as purchasing raw materials, paying salaries or covering operational costs.
Cash Credit Meaning Explained
Cash credit refers to a borrowing arrangement where a bank sanctions a specific credit limit against the borrower’s inventory, receivables or other assets.
The borrower can use any amount within this limit and is required to pay interest only on the amount utilised, not on the entire limit.
This feature makes cash credit a flexible and cost-effective financing option for businesses that face irregular cash flows.
How a Cash Credit Loan Works?
A cash credit loan is usually backed by collateral, such as stock or other business assets. The bank evaluates the financial health of the business and sets a borrowing limit.
The borrower can deposit or withdraw funds multiple times within the sanctioned limit. This revolving nature of the credit makes it similar to an overdraft facility, but it is primarily meant for business needs.
Example of Cash Credit Interest Applicability
The cash credit interest rate is generally lower than that of unsecured business loans, but may vary based on the borrower’s creditworthiness and relationship with the bank.
Suppose a manufacturing firm has a cash credit limit of ₹20 lakh. If the firm withdraws ₹10 lakh, interest will be charged only on that ₹10 lakh.
As the amount is repaid, funds can be withdrawn again within the limit, offering flexibility in managing working capital.
Therefore, cash credit is a practical and efficient way for businesses to maintain liquidity and meet short-term financial obligations without facing cash shortages.
