Who can avail facility of Overdraft and Cash Credit (CC a/c).
Cash credit Account
This account is the primary method in which Banks lend money against the security of commodities and debt. It runs like a current account except that the money that can be withdrawn from this account is not restricted to the amount deposited in the account. Instead, the account holder is permitted to withdraw a certain sum called "limit" or "credit facility" in excess of the amount deposited in the account.
Cash Credits are, in theory, payable on demand. These are, therefore, counter part of demand deposits of the Bank.
Overdraft The word overdraft means the act of overdrawing from a Bank account. In other words, the account holder withdraws more money from a bank account than has been deposited in it.
How does this account then differ from a Cash Credit Account? The difference is very subtle and relates to the operation of the account. In the case of Cash Credit, a proper limit is sanctioned which normally is a certain percentage of the value of the commodities/debts pledged by the account holder with the Bank. Overdraft, on the other hand, is allowed against a host of other securities including financial instruments like shares, units of mutual funds, surrender value of LIC policy and debentures etc. Some overdrafts are even granted against the perceived "worth" of an individual. Such overdrafts are called clean overdrafts.
There are many ways in which finance can be raised Cash Credit is one of the many ways of raising finance (i.e. it is a type of loan account).
Meaning : Cash credit is an arrangement under which a customer of a bank or financial institution is allowed an advance up to certain limit against credit granted by bank. That means a loan may be granted say for Rs. 1 Lakh however the customer/borrower of the loan may take the amount of loan to the extent required by him but not exceeding the limit of Rs. 1 Lakhs.
Purpose : The purpose for which loan is required is essential to ascertain, as for different purposes different types of loan can be taken. E.g., In case the loan is required to purchase fixed assets like plant and machinery, term loan must be taken as plant and machinery are long term assets it will take time in repayment of the loan and repayment can be done in EMI’s (Equated Monthly Installments). Where as a loan required for working capital needs a long term loan is not required as repayment does not require long period, hence cash credit may be availed. Explanation of Cash Credit loan facility : If for e.g., a person is having a business. To carry on this business he needs to purchase raw material, and sell the goods. For this he needs working capital to run his daily business. Working capital means current assets minus current liabilities. Where current assets comprise of investment in stock, sundry debtors, cash, etc., current liabilities comprise of sundry creditors, suppliers of stock (incase of stock taken on credit), etc. The reason working capital is current asset minus current liabilities because money is required to purchase stock, this stock when still not sold will be of some value for which cash is invested in it and the part that is sold but on credit to customers(debtors) here also cash is not received and cash is invested. Hence in both the items money is put in. On the other hand, in case of stock which is purchased on credit (creditors) here no money is put in, i.e., the stock purchased without investment. Hence total amount of money put in or invested in running the business is only to the extent of money invested in stock in hand (for which money is paid) and debtors (where again money is invested) less the amount of stock received on credit form creditors(here the amount is not invested for purchase of stock).
This working capital that is required to run the business can be either funded by the businessman himself or if he does not have the money he can take a loan i.e. Cash credit. In Cash Credit facility an amount of loan is given to the borrower/businessman for his working capital needs. The entire amount of working capital required is not funded by the bank, some small amount will have to be funded by the businessman and the balance amount will be funded by a bank as a loan. This is as per RBI rules. The amount of loan to be given is decided on the basis of different types of methods like MPBF (Maximum Permissible Bank Finance) suggested by Tandoon Committee or other methods. These methods use formulas which take into consideration actual working capital required.
The amount so worked out is given as loan and is called as “limit” this is because under this kind of loan the borrower may not take up the entire amount of loan as working capital requirement every day is not the same.
Any entity which is in a position to offer the sound security and undertakes to maintain financial discipline can avail of the overdraft/cash credit facility.