Cash Credit

Cash Credit — Meaning, Definition & Full Explanation

Cash Credit (CC) is a short-term working capital facility provided by banks to businesses, firms, and companies to meet their day-to-day operational expenses. It allows borrowers to draw funds up to a pre-sanctioned limit against the security of current assets like inventory and receivables. Interest is charged only on the amount actually utilized, offering flexibility for managing fluctuating liquidity needs.

What is Cash Credit?

Cash Credit is a crucial financial instrument designed to bridge the gap between a business's operational cycle and its cash inflows. It functions as a revolving credit facility, meaning funds can be drawn, repaid, and redrawn multiple times within the sanctioned limit and tenure. Unlike a term loan, which is disbursed as a lump sum, a Cash Credit account operates much like a current account where the outstanding balance can fluctuate daily. This facility is primarily used to finance working capital requirements such as purchasing raw materials, paying wages, or managing inventory, ensuring smooth business operations without disruption due to short-term cash shortages. The limit for a Cash Credit facility is determined by the bank based on the borrower's projected working capital cycle and the value of the collateral offered.

How Cash Credit Works

A Cash Credit facility begins when a bank sanctions a maximum borrowing limit to a business. This limit is typically secured by the borrower's current assets, such as inventory (stock) and accounts receivable (debtors). The bank establishes a 'drawing power' based on periodic statements of these current assets, usually submitted monthly. The drawing power is the actual amount the business can withdraw at any given time, which is often less than the sanctioned limit to provide a margin of safety for the bank.

Here’s how it typically works:

1. Sanction Limit: The bank assesses the business's working capital needs and financial health to approve a maximum Cash Credit limit.
2. Collateral: The business hypothecates its current assets (e.g., raw materials, work-in-progress, finished goods, book debts) to the bank as security.
3. Drawing Power Calculation: Periodically (e.g., monthly), the business submits stock and book debt statements. The bank calculates the drawing power by applying a margin (e.g., 25% on stock, 30% on debtors) to the value of these assets.
4. Fund Utilization: The business can withdraw funds from its Cash Credit account up to the calculated drawing power or the sanctioned limit, whichever is lower.
5. Interest Payment: Interest is charged only on the actual amount utilized from the Cash Credit facility, not on the entire sanctioned limit. This makes it a cost-effective option for managing variable cash flow.
6. Repayment and Redrawing: Funds can be repaid into the account at any time, reducing the outstanding balance and interest burden. The business can then redraw funds as needed, up to the available drawing power. This revolving nature provides immense flexibility.

Cash Credit in Indian Banking

In Indian banking, Cash Credit (CC) is a cornerstone of working capital finance, particularly for Micro, Small, and Medium Enterprises (MSMEs) and larger corporates. The Reserve Bank of India (RBI) provides broad guidelines for working capital finance, which banks like SBI, HDFC Bank, ICICI Bank, and Punjab National Bank adhere to when offering CC facilities. These guidelines cover aspects like assessment methods (e.g., Turn Over Method, Working Capital Gap Method), security norms, and interest rate policies. For instance, RBI's Master Circular on Working Capital Facilities for banks dictates how banks should assess and monitor these facilities.

Typically, in India, a Cash Credit facility is secured by the hypothecation of current assets and often requires additional collateral like fixed assets or personal guarantees, especially for smaller businesses. Banks regularly review the CC limits and drawing power based on the borrower's performance and updated stock/debtor statements. The interest rates on Cash Credit are usually floating, linked to the bank's MCLR (Marginal Cost of Funds based Lending Rate) or an external benchmark. For candidates preparing for banking exams like JAIIB and CAIIB, understanding Cash Credit is fundamental, as it forms a significant part of the "Working Capital Management" and "Credit Management" modules, covering its features, assessment, and operational aspects within the Indian financial system.

Practical Example

ABC Textiles Ltd., a Surat-based MSME manufacturing cotton fabrics, experiences seasonal demand fluctuations. During the festive season (September-December), they need to purchase large quantities of raw cotton and increase production, leading to higher working capital requirements. To manage this, ABC Textiles has a ₹2 crore Cash Credit facility with Axis Bank, secured by their inventory of raw materials and finished goods, and their accounts receivables.

In October, to meet anticipated demand, ABC Textiles needs ₹1.5 crore for raw cotton. Their current drawing power, based on their September stock statement, is ₹1.8 crore. They withdraw ₹1.5 crore from their Cash Credit account. As they sell the fabrics and receive payments from distributors in November and December, they deposit these funds back into the CC account, reducing their outstanding balance. For instance, if they deposit ₹80 lakh in November, their outstanding balance drops to ₹70 lakh (₹1.5 crore - ₹80 lakh). They are charged interest only on the amount actually utilized (e.g., ₹1.5 crore for part of October, then ₹70 lakh for part of November). This flexibility allows ABC Textiles to manage its cash flow efficiently, paying interest only when funds are actively used, without having to seek new loans for each short-term need.

Cash Credit vs Overdraft

Feature	Cash Credit (CC)	Overdraft (OD)
Purpose	Primarily for business working capital needs	Can be for personal or business needs
Security	Typically secured by current assets (inventory, receivables)	Often secured by fixed deposits, shares, or property; sometimes unsecured
Borrower Type	Businesses, firms, companies	Individuals, salaried employees, businesses
Assessment	Based on working capital cycle, stock/debtor statements	Based on income, collateral value, or relationship with bank

While both Cash Credit and Overdraft facilities allow drawing funds beyond the available balance, Cash Credit is specifically tailored for business working capital, secured by current assets, with drawing power linked to their value. Overdrafts, on the other hand, can be availed by individuals or businesses, often against fixed assets or even as a clean facility for high-net-worth customers, with less emphasis on daily asset-based drawing power. Cash Credit is a more structured and dynamic facility for managing ongoing business liquidity.

Key Takeaways

• Cash Credit (CC) is a short-term working capital finance facility for businesses.
• It operates as a revolving credit, allowing multiple withdrawals and repayments within a sanctioned limit.
• Interest is charged only on the amount actually utilized, not on the entire sanctioned limit.
• The facility is typically secured by current assets like inventory and accounts receivable.
• Drawing power, the maximum drawable amount, is periodically calculated based on the value of collateral.
• Cash Credit is a crucial tool for MSMEs in India to manage their operational cash flow fluctuations.
• The Reserve Bank of India (RBI) provides guidelines for banks offering Cash Credit facilities.
• Understanding Cash Credit is important for banking professionals and candidates of JAIIB/CAIIB exams.

Frequently Asked Questions

Q: Is Cash Credit a secured loan? A: Yes, Cash Credit is primarily a secured loan facility. Banks typically require the hypothecation of current assets like inventory (stock) and accounts receivable (debtors) as primary security, and sometimes additional collateral or personal guarantees.

Q: How is interest calculated on a Cash Credit account? A: Interest on a Cash Credit account is calculated daily on the actual amount utilized by the borrower, not on the full sanctioned limit. This allows businesses to minimize interest costs by repaying funds as soon as they become available.

Q: Can an individual get a Cash Credit facility? A: Generally, Cash Credit facilities are extended to businesses, firms, and companies to meet their working capital needs. Individuals typically opt for personal loans or overdraft facilities, which are structured differently from a business-oriented Cash Credit.