Cash Credit (CC): A Comprehensive Guide for Businesses

A Cash Credit (CC) is a short-term source of financing for a company. In other words, a cash credit is a short-term loanBridge LoanA bridge loan is a short-term form of financing that is used to meet current obligations before securing permanent financing. It provides immediate cash flow when funding is needed but is not yet available. A bridge loan comes with relatively high interest rates and must be backed by some form of collateral extended to a company by a bank. It enables a company to withdraw money from a bank account without keeping a credit balance. The account is limited to only borrowing up to the borrowing limit. Also, interestSimple InterestSimple interest formula, definition and example. Simple interest is a calculation of interest that doesn't take into account the effect of compounding.  In many cases, interest compounds with each designated period of a loan, but in the case of simple interest, it does not.  The calculation of simple interest is equal to the principal amount multiplied by the interest rate, multiplied by the number of periods. is charged on the amount borrowed and not the borrowing limit.  To learn more, check out CFI’s Credit Analyst Certification programProgram Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses..

Important Features of Cash Credit

1. Borrowing limit

A cash credit comes with a borrowing limit determined by the creditworthiness of the borrower. A company can withdraw funds up to its established borrowing limit.

2. Interest on running balance

In contrast with other traditional debt financing methods such as loans, the interest charged is only on the running balance of the cash credit account and not on the total borrowing limit.

3. Minimum commitment charge

The short-term loan comes with a minimum charge for establishing the loan account regardless of whether the borrower utilizes the available credit. For example, banks typically include a clause that requires the borrower to pay a minimum amount of interest on a predetermined amount or the amount withdrawn, whichever is higher.

4. Collateral security

The credit is often secured using stocksStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably., fixed assetsTangible AssetsTangible assets are assets with a physical form and that hold value. Examples include property, plant, and equipment. Tangible assets are, or property as collateral.

5. Credit period

Cash credit is typically given for a maximum period of 12 months, after which the drawing power is re-evaluated.

Example of Cash Credit

Company A is a phone manufacturer and operates a factory where the company invests money to purchase raw materials to convert them into finished goods. However, the finished goods inventory is not immediately sold. The company’s capital is stuck in the form of inventory. In order for Company A to meet its expenses while waiting for their finished goods inventory to convert into cash, the company takes a cash credit loan to run their business without a shortfall.

Advantages of Cash Credit

1. Source of working capital financing

A cash credit is an important source of working capital financing, as the company need not worry about liquidity issues.

2. Easy arrangement

It can be easily arranged by a bank, provided that collateral security is available to be pledged and the realizable value of such is easily determined.

3. Flexibility

Withdrawals on a cash credit account can be made many times, up to the borrowing limit, and deposits of excess cash into the account lowers the burden of interest that a company faces.

4. Tax-deductible

Interest payments made are tax-deductible and, thus, reduce the overall tax burden on the company.

5. Interest charged

A cash credit reduces the financing cost of the borrower, as the interest charged is only on the utilized amount or minimum commitment charge.

Disadvantages

1. High rate of interest

The interest rateInterest RateAn interest rate refers to the amount charged by a lender to a borrower for any form of debt given, generally expressed as a percentage of the principal. charged by a loan on cash credit is very high as compared to traditional loans.

2. Minimum commitment charges

A minimum commitment charge is imposed on the borrower regardless of whether the company utilizes its cash credit or not.

3. Difficulty in securing

The short-term loan is extended to the borrower depending on the borrower’s turnover, accounts receivable balance, expected performance, and collateral security offered. Therefore, it can be difficult for new companies to obtain.

4. Temporary source of finance

The loan is a short-term source of financing. A company cannot rely on it for an extended period of time. After the expiration of the loan, it must be renewed under new terms and conditions.

Other Resources

Thank you for reading CFI’s explanation of Cash Credit. CFI offers the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• Bullet LoanBullet LoanA bullet loan is a type of loan in which the principal that is borrowed is paid back at the end of the loan term. In some cases, the interest expense is
• Cost of DebtCost of DebtThe cost of debt is the return that a company provides to its debtholders and creditors. Cost of debt is used in WACC calculations for valuation analysis.
• PIK LoanPIK LoanA payment-in-kind or PIK loan is a loan where the borrower is allowed to make interest payments in forms other than cash.
• Revolving DebtRevolving DebtA revolving debt (a "revolver", also sometimes known as a line of credit, or LOC) does not feature fixed monthly payments. It differs from a fixed payment or term loan that has a guaranteed balance and payment structure. Instead, the payments of revolving debt are based on the balance of credit every month.