Every Small business owners face cash shortages at certain times and need more funds to continue their business operations. Cash credit helps them at some difficult times. Cash credit is an extremely popular financial facility that banks and financial institutions offer to help business owners satisfy their immediate working capital requirements.
In the following article, we will discuss the key features of cash credit, how it is used, and when a business owner should apply for it.
What is Cash Credit, and How Does it Work?
Cash credit works like an overdraft facility where the borrower is allowed to withdraw money from a bank account even if there is no balance, up to a certain limit. This limit is usually based on the business’s current assets, inventory or stock, and accounts receivables.
For example, let’s say a small business has seasonal sales. For some periods of the year, sales may be low, hence the business cannot pay for all the necessary expenses, like suppliers or employees. Under such circumstances, the business can avail of a cash credit facility to borrow money when required to continue running until sales peak again. In this case, only the amount drawn is charged interest but not the full limit. Many businesses see this as an alternative to a business loan.
Here is how cash credit works
A bank gives cash credit limits on the basis of the business’s assets and stocks.
The businesses can withdraw amounts up to the granted limit. Whether they have that particular amount in the bank account or not
- Borrowed amount is charged with interest. The total amount limit is not charged with the interest.
- Funds can be utilized for daily usage to buy raw materials or to pay the employees or operational expenses.
- The loan is secured by utilizing the business’s assets, such as inventories or accounts receivables.
Features of Cash Credit
Cash credit offers several attractive features for business owners. Consequently, it has become a very popular source of working capital financing. Here are some of the important features:
Revolving Credit Facility: Cash credit works as a revolving line of credit, which means that the business can borrow money, pay it off, and once again borrow when there is a need to do so. It ensures that funding is available for use by the business without having to apply for a new loan every time.
Interest on Utilised Amount: One of the principal benefits of cash credit is that interest is only charged against the amount physically withdrawn, and not against the entire sanctioned limit. In a business scenario where the firm does not necessarily require the full amount of credit available, it can help save interest costs that would otherwise be incurred. Payments are to be made on the outstanding amount withdrawn either monthly or quarterly basis which is mostly settled upon terms agreed between the bank and the business.
Short-Term Financing: Cash credit is intended for short-term requirements, say one year or less. It is not for long-term investment or acquisition of fixed assets. Therefore, it is important to use working capital management when there are low cash flows.
Secured Loan: Most cash credit facilities are covered by assets like stock-in-hand, raw materials, or receivables. That is, the business owners have to pledge their assets as security to get a loan. However, some banks may grant unsecured cash credit to better-established businesses with good financials.
Flexible Withdrawals: Any small business owner can withdraw up to the granted amount on demand. Repayment is not time-bound, so it’s a flexible and convenient option in case of fluctuating cash flows for a business.
Renewable Facility: Many banks also provide businesses the facility to renew the cash credit facility in case they fail to repay the total amount of the cash credit on the expiry of the loan tenure, if and only if the business maintains good credit discipline. In this way, the business will continue to avail the facility so long as it needs.
When to Apply for the Cash Credit Facility
Cash credit is an effective financial tool but must be applied appropriately. Here are some scenarios when a business must consider making an application for a cash credit facility:
Seasonal Business: Businesses that operate on seasonal patterns of cash flows – say, crackers shops or agricultural companies face cash flow issues during low seasons. That’s when cash credit would help them spend their time until things pick up again.
Shortage of working capital: It will generally require cash to continue its business activities, especially during high growth, and cash credit to fund purchases of inventories, payments for supplies, or salary accounts with the possibility of not waiting for customers’ payment.
Delayed Payments from Customers: The customers of some industries take a long time to pay their invoices. Consequently, there is always a cash shortage in the business. A cash credit facility can give the required funds to meet these costs till the inflow of delayed payments.
Emergency Situations: Sometimes, a business is affected by unforeseen expenditures like machinery repairs, shop breakdowns, or unexpected opportunities that demand immediate action. With cash credit facilities, the business is always in a position to generate funds when needed.
Short-term financing needs: When a business is required to produce a large order for a customer by a certain deadline or has to enter into some other short-term activity, then cash credit can come out to be a very good option.
Conclusion
Cash credit is a helping hand financial instrument for small business owners as it helps provide a cash credit that is flexible enough to cover short-term working capital needs which enables the small business owner to run the operations smoothly even in situations where shortages of funds occur due to delay in payments from customers or seasonal fluctuations. Cash credit is used as it saves on interest paid in respect of the amount used; flexible withdrawals can be done directly into an account; and loan structure is secured.
Therefore, this facility can actually minimize the huge financial burden on businesses to a great extent but should be used responsibly and with careful analysis about whether a business really requires borrowed funds or not for being over-dependent on borrowed funds.
Additionally, NBFCs in India have proved to be very good options for MSME business owners in availing of unsecured business loans. NBFCs provide the facility for business loans with flexible repayment and lesser documentation than traditional banks.
Most NBFCs, today, operate digitally. This allows MSMEs to apply for loans online, seek quick approval, and get transferred directly into their accounts. The urgent financial requirements of a small business owner become relatively easy to arrange and give them more time and room to think about growth and success.
