Cash Credit Account – Definition and Meaning

"Change is the only thing constant in this world”.

With cut throat competition in the current economy, the business needs and requirements are on the rise and the same will only increase with the passage of time. At, this juncture, Cash credit acts as one of the catalyst to the stated situation.

A Cash Credit is a type of loan account provided by banks under corporate solution which helps to support working capital requirement. As the business requirements changes daily so is the working capital. A perfect product “Cash Credit” is a loan or continuous overdrawn facility unlike current a/c were overdrawn facility is provided occasionally.

Under this arrangement a limit is sanctioned say Rs.10.00 lacs. Now, the owner can utilise this limit to the extent required. Suppose the owner needs Rs.8.25 lacs for making payment towards Raw material. He can do so by instructing bank for remittance. The balance left is Rs.1.75 lacs. Now, further the owner need to make payment for stores supplies for Rs.2.00 lacs, but here, now the remittance can be done upto the limit of free balance which is Rs.1.75 lacs. Further, some payment is deposited by the debtor in the same account. Again, there will be some free balance, which can be utilised for further remittance.

Now, let’s understand what is working capital? By formula Working capital = Current assets – Current liabilities. Where, current assets includes inventory, debtors/receivables, cash & cash equivalents etc. and current liabilities includes payables, any short term payments etc.

The Working Capital cycle

                             

To support the smooth functioning of the above cycle, Cash credit account comes into the picture.

Based on the working capital requirement, bank sanctions a limit which is not 100% of the requirement, but a little less. Some amount of capital should also be brought in by the owner in the name of margin, which could vary from 10% to 25%. The limit sanctioned by the bank is based on the Maximum Permissible Bank Finance (MPBF). 

Collateral needs to be provided against the limit. The same is done by hypothecating inventory or debtors in most of the cases or some fixed assets.

As per the new guidelines of RBI, interest is charged on daily basis on the closing balance. Under this arrangement the interest is charged on the utilised amount and not on the limit  

amount. This is one of the biggest advantages of the cash credit account.

he rate of interest charged by the bank is dependent on firm’s bank rating/external rating by some external agency, past financial performance etc. One clause attached to most of  the account is that if the limit is not utilised upto 60% per quarterly or biannually or annually depending up on the bank, there could be a penal interest on the unutilised amount(60% of the limit – utilised amount). The penal interest varies from 1.00% to 2.00%