Cash Credit, Features, Types, Advantages, Disadvantages

Cash Credit (CC) is a short-term borrowing facility provided by banks to businesses to meet their working capital requirements. Under this arrangement, the bank allows the borrower to withdraw funds up to a pre-approved limit against security or collateral, such as stock, receivables, or other assets. Interest is charged only on the amount utilized, not on the sanctioned limit, making it a flexible financing tool. Cash credit helps businesses manage day-to-day operations, including purchase of raw materials, payment of wages, and meeting other operational expenses. It is widely used by trading and manufacturing firms in India. Banks periodically review the account and ensure proper accounting, monitoring, and repayment discipline.

Important Features of Cash Credit:

• Short-Term Borrowing Facility

Cash credit (CC) is primarily a short-term borrowing facility offered by banks to meet the working capital needs of businesses. Typically sanctioned for a period of one year, it is renewable based on bank review. The short-term nature allows businesses to manage daily operational expenses like wages, raw material purchases, and overheads without arranging long-term finance. Interest is charged only on the amount actually utilized, making it cost-effective. This feature ensures flexibility in fund management, allowing borrowers to efficiently handle liquidity requirements while maintaining banking discipline and regulatory compliance.

• Sanctioned Limit and Utilization

Banks sanction a specific limit for cash credit based on the borrower’s financial health, creditworthiness, and security offered. The borrower can withdraw funds up to this limit as needed. Interest is levied only on the amount drawn, not on the full sanctioned limit, which makes cash credit flexible and efficient. The sanctioned limit is reviewed periodically by banks to ensure proper utilization and repayment capability. This feature helps businesses manage cash flow efficiently, avoid unnecessary interest costs, and meet temporary shortfalls in working capital without borrowing beyond their needs.

• Security or Collateral Requirement

Cash credit is generally granted against security or collateral, such as stock of goods, receivables, or other tangible assets. This ensures safety for the bank while providing flexibility to the borrower. The security reduces the risk of default and provides recourse in case of non-payment. Banks in India follow RBI guidelines to value and monitor the collateral regularly. The security-backed nature of cash credit encourages disciplined borrowing, protects bank funds, and aligns with prudent lending practices, ensuring the borrower uses the facility responsibly for genuine working capital requirements.

• Revolving Nature of Credit

Cash credit is a revolving credit facility, allowing the borrower to withdraw, repay, and redraw funds multiple times within the sanctioned limit. This feature provides liquidity flexibility for businesses facing fluctuating working capital needs. Unlike term loans, where funds are disbursed once, cash credit ensures continuous availability of funds for operational requirements. Banks monitor withdrawals and repayments to maintain discipline. The revolving nature also helps businesses manage seasonal variations in demand, ensuring uninterrupted production or trading activities, while interest is charged only on the utilized portion, making it an efficient and cost-effective short-term financing tool.

• Interest on Actual Utilization

One key feature of cash credit is that interest is charged only on the amount actually utilized, not the full sanctioned limit. This makes the facility cost-effective compared to conventional loans, as borrowers avoid paying interest on idle funds. Banks calculate interest daily or monthly on withdrawals, and repayments reduce the interest burden proportionally. This encourages responsible fund usage and efficient working capital management. Businesses benefit from lower financing costs while maintaining liquidity, and banks benefit from interest income on actual utilization, balancing risk and profitability effectively.

Types of Cash Credit:

• Hypothecation Cash Credit

Hypothecation Cash Credit (HCC) is a facility where the borrower’s goods or stock are offered as security without transferring ownership to the bank. The borrower retains possession and can sell or use the goods in daily operations. The bank holds a charge on the stock or receivables, and lending is based on periodic stock statements and financial monitoring. Interest is charged on the utilized amount, and the sanctioned limit is usually reviewed regularly. Hypothecation CC is widely used by trading and manufacturing firms to finance working capital requirements, as it provides flexibility while ensuring the bank’s security against potential default.

• Pledge Cash Credit

Pledge Cash Credit (PCC) involves physical delivery of goods to the bank as security for the loan. The bank retains possession of the pledged stock, and the borrower cannot use or sell the goods without consent. Interest is charged on the amount drawn, and the borrowing limit depends on the value of the pledged goods. This type of cash credit provides high security for the bank and is suitable for commodities or goods with stable market value. Pledge CC is commonly used in commodity trading and inventory financing, reducing risk of default while allowing the borrower to obtain funds against tangible assets.

• Clean Cash Credit

Clean Cash Credit (CCC) is a loan without any physical collateral or security, granted based on the borrower’s creditworthiness, financial reputation, and repayment capacity. Banks assess the borrower’s business track record, financial statements, and standing in the market before sanctioning such credit. Interest is charged on the amount utilized, and the sanctioned limit may be reviewed periodically. Clean CC carries higher risk for the bank due to lack of collateral, so it is usually extended to trusted and financially sound borrowers. This facility provides maximum flexibility for businesses to manage working capital efficiently while relying on their credibility and financial discipline.

Advantages of Cash Credit:

• Flexible Fund Availability

Cash credit provides flexible access to funds up to the sanctioned limit. Borrowers can withdraw money as needed, repay, and redraw multiple times. This revolving facility ensures that businesses can manage fluctuating working capital requirements, meet urgent operational expenses, and handle seasonal variations in production or sales. Unlike term loans, interest is charged only on the amount utilized, making it cost-effective. The flexibility of cash credit helps maintain smooth operations, reduces dependence on multiple loans, and allows businesses to efficiently manage liquidity, ensuring uninterrupted business activities and better financial planning.

• Interest on Actual Utilization

One major advantage of cash credit is that interest is levied only on the utilized amount, not the full sanctioned limit. This reduces borrowing costs, making the facility economical for businesses. Daily or monthly interest calculation ensures transparency and encourages responsible use of funds. Since the borrower is charged only for funds actually drawn, idle money does not incur unnecessary interest, improving cost efficiency. This feature is particularly useful for businesses with variable cash flow requirements, enabling them to balance liquidity with interest expense, maintain financial discipline, and optimize working capital management.

• Helps in Working Capital Management

Cash credit is primarily designed to meet short-term working capital needs such as purchase of raw materials, payment of wages, and day-to-day operational expenses. By providing timely liquidity, it ensures uninterrupted business operations. Businesses can manage seasonal fluctuations, unexpected expenses, and temporary cash shortfalls without arranging multiple loans. The facility enhances operational efficiency, reduces dependence on informal sources, and supports smooth production and trading activities. By aligning borrowing with actual operational needs, cash credit helps maintain financial discipline, cost efficiency, and better control over working capital, supporting overall business growth.

• Quick and Easy Access to Funds

Cash credit allows businesses quick access to funds once the limit is sanctioned. Banks usually require minimal documentation compared to term loans, especially for revolving facilities. The speed of disbursement helps in handling urgent operational requirements, emergencies, or sudden business opportunities. Quick access reduces delays in procurement, production, or sales, ensuring smooth cash flow management. This advantage is particularly beneficial for small and medium enterprises (SMEs) and trading firms, where operational efficiency and timely payments directly impact profitability. The facility enhances business agility and financial responsiveness in a competitive market.

Disadvantages of Cash Credit:

• High Cost of Borrowing

A Cash Credit account is typically a high-interest form of financing. Interest is charged on the daily outstanding balance, making it an expensive source of capital compared to traditional term loans. Furthermore, banks often charge a commitment fee on the unutilized portion of the sanctioned limit, penalizing the borrower for not using the full facility. This high cost can significantly erode a company’s profitability, especially for businesses with tight margins, making it a less efficient tool for long-term funding needs.

• Complex Administration and Monitoring

For banks, administering a Cash Credit facility is operationally intensive. It requires continuous monitoring of the account, regular audits of the pledged stock and receivables, and ensuring the drawing power aligns with the current collateral value. This process is complex, manual, and costly. For borrowers, it involves maintaining meticulous records for audit and facing potential restrictions if the collateral value dips, adding a significant administrative overhead that diverts focus from core business operations.

• Prone to Misuse and “Evergreening”

The flexibility of drawals and repayments makes Cash Credit prone to misuse. Businesses might use this short-term working capital loan for unintended purposes like purchasing fixed assets, leading to asset-liability mismatches. More dangerously, it facilitates “evergreening” of loans—where banks extend new credit to help a borrower repay old installments, hiding the true status of a non-performing asset (NPA). This practice undermines credit discipline, masks financial stress, and poses a significant risk to the stability of the banking system.

• Collateral Dependency and Rigid Limits

The facility’s core reliance on collateral security (stock, receivables) creates a major disadvantage. A downturn in the market can reduce inventory value, instantly lowering the drawing power and crippling a business’s access to crucial funds exactly when needed. The sanctioned limit is also rigid; sudden growth or a large order cannot be funded without a lengthy bank review. This lack of flexibility can strangle a business’s growth potential and operational agility.