Cash Credit, Overdraft or Working Capital Term Loan: Which Bank Facility Fits Your Business
A cash credit lets you draw up to a limit secured on stock and receivables, with interest only on the amount used. An overdraft works similarly, usually secured on a deposit or property. A working capital term loan gives a fixed sum repaid in instalments. Seasonal needs suit CC or OD; a permanent gap suits a term loan.
A banker offers a small business three ways to fund working capital, and the sanction letter rarely explains the difference in plain terms. The choice changes what you pay interest on, what you must report every month and how much flexibility you have. This post compares the three, with the arithmetic for a seasonal business.
The three facilities at a glance
| Cash credit (CC) | Overdraft (OD) | Working capital term loan (WCTL) | |
|---|---|---|---|
| Security | Hypothecation of stock and book debts | Fixed deposit, property, or sometimes unsecured for strong borrowers | Stock, debtors, property, as sanctioned |
| How you draw | Any amount up to the lower of limit and drawing power | Any amount up to the limit | Full amount at disbursement |
| Interest on | Daily debit balance | Daily debit balance | Full outstanding principal |
| Repayment | Revolving; limit renewed each year | Revolving; renewed or ends on FD maturity | Fixed instalments over the tenure |
| Monthly reporting | Stock and debtor statement | Usually none for FD-backed OD | Usually none beyond annual financials |
| Best for | Trading and manufacturing with fluctuating stock | Short, irregular needs; service firms | A permanent or core funding gap |
Cash credit
A CC limit is a running account. You draw and repay as cash comes and goes, and interest is charged on the daily debit balance, usually debited monthly. What you can draw is capped by drawing power, worked out from your stock and receivables statement; we have covered that calculation separately.
RBI rules for urban co-operative banks say drawals are allowed against drawing power computed after excluding unpaid stocks, and require monthly stock statements with periodic physical checks. Commercial banks follow similar practice under their board-approved policies.
For micro and small enterprises, the RBI's MSME Master Direction asks banks to review regular working capital limits annually, with a higher limit where the previous year's actual sales justify it. In practice, renewal needs audited or provisional financials, the stock statements, and a clean account conduct record.
Overdraft
An OD works like a CC in drawing and interest, but is secured differently:
- ✓OD against a fixed deposit: the limit is a percentage of the FD, priced at a margin over the FD rate. Quick to set up, no stock statements.
- ✓OD against property: larger limits, longer tenure, and a property mortgage.
- ✓Unsecured business OD: offered to some borrowers with strong records, at higher rates.
An OD suits a business whose need is irregular rather than tied to stock, such as a services firm waiting on large client payments.
Working capital term loan
A WCTL is a fixed amount repaid in instalments, typically over a few years. Banks use it to fund the core part of working capital that never really gets repaid, and sometimes to convert an irregular or overdrawn portion of a CC into a structured loan. You pay interest on the full outstanding amount whether or not the cash is sitting idle in your current account.
Interest rates and charges
- ✓For micro and small enterprises, all new floating-rate loans from scheduled commercial banks have been linked to an external benchmark (such as the RBI repo rate) since 1 October 2019, with a reset at least once every three months. Your rate is the benchmark plus a spread.
- ✓Since 1 January 2024, if you breach a loan condition, such as overdrawing beyond drawing power, the bank can levy a penal charge, disclosed in the sanction and key fact statement. It cannot add a penal interest rate to your loan rate, and penal charges cannot be compounded.
- ✓Read the sanction letter for processing fees, renewal fees, stock audit fees and any charge on unused limits.
A worked example
A Surat textile trader needs ₹50 lakh during the four-month wedding and festival season, and about ₹10 lakh for the other eight months. The bank offers either a ₹50 lakh CC at 10.5% or a ₹50 lakh WCTL at 10%.
Cash credit: interest only on what is drawn
| Step | Figure |
|---|---|
| Average use: (₹50 lakh × 4 + ₹10 lakh × 8) ÷ 12 | ₹23,33,333 |
| Interest: ₹23,33,333 × 10.5% | ₹2,45,000 |
Working capital term loan: interest on the full amount (ignoring instalment repayments in the year, for simplicity)
| Step | Figure |
|---|---|
| Outstanding | ₹50,00,000 |
| Interest: ₹50,00,000 × 10% | ₹5,00,000 |
The CC costs ₹2,55,000 less, even at a higher rate, because the trader pays only for the months it needs the money. A WCTL would make sense only if the ₹50 lakh were needed all year.
A sensible mix for this trader: a CC for the seasonal swing, and a small WCTL for the ₹10 lakh it needs all year, if the bank prices the term loan lower.
Frequently asked questions
Can I have both a CC and a WCTL?
Yes. Many banks sanction a mix: a term loan for the core requirement and a CC for the fluctuating part.
What happens if I do not renew my CC on time?
The account can be treated as out of order and the bank may stop drawals. Submit renewal papers well before the due date.
Is an OD against my FD a good idea?
For short gaps, often yes. You keep the FD earning interest and pay only for the days you use the OD.
Does a CC need collateral beyond stock?
For micro and small enterprise loans up to ₹20 lakh, RBI rules bar banks from taking collateral. Above that, banks may ask for property or guarantees.
Sources
- ✓Master Direction: Lending to MSME Sector, RBI
- ✓Master Circular: Management of Advances (UCBs), RBI
- ✓External Benchmark Based Lending, RBI circular of 4 September 2019
- ✓Fair Lending Practice: Penal Charges in Loan Accounts, RBI circular of 18 August 2023
This is a summary, not legal advice and not financial advice. Confirm terms in your sanction letter and with your bank, and check current RBI directions on rbi.org.in.
Written by
Founder, Airwix Technologies (Sleet)
Vatsal Sutariya is the founder of Airwix Technologies in Ahmedabad, the company that builds Sleet: SleetHR for HR and payroll, and Sleet Accounting for GST billing and books. He writes about GST, invoicing, business tax and choosing software for Indian businesses, and checks each rule against the official notification before it is published.
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