Cash credit, overdraft, term loan or invoice discounting?

The five main facilities

Cash credit

Cash credit is the traditional bank facility for working capital. The bank sanctions a limit against your stock and receivables, and you draw and repay as often as you like within it. Interest is charged only on the amount actually used, day by day.

• Drawing power. What you can actually draw depends on current stock and receivables less a margin, not just the sanctioned limit. If stock falls, drawing power falls with it.
• Stock statements. You submit periodic statements of stock and book debts, and the bank may inspect or audit them.
• Renewal. The limit is reviewed, usually every year, on fresh financials. It is repayable on demand in law, though in practice it rolls over while the account is conducted well.
• Security. Hypothecation of stock and receivables, commonly backed by collateral such as property, or by a credit guarantee cover.

It suits businesses with steady stock and receivables throughout the year. It takes time to set up and demands regular paperwork.

Overdraft

An overdraft lets you draw beyond the balance in your current account up to a limit. It works like cash credit — revolving, with interest on the amount used — but it is usually sanctioned against a specific security such as property or a fixed deposit, or sometimes unsecured on the strength of the account, rather than against stock statements. An overdraft against your own fixed deposit is among the cheapest and quickest credit there is. It suits short, irregular gaps: a tax payment before a large receipt, or a seasonal purchase.

Term loan

A term loan is a fixed sum, disbursed once or in stages, repaid in instalments over a fixed tenure. It is the right instrument for things that last: machinery, vehicles, premises, a new line or outlet. The asset earns over several years, and the loan is repaid over a similar period out of those earnings. The lender usually takes a charge on the asset financed and may ask for further collateral. Once repaid, the money cannot be redrawn.

Invoice discounting

Here the financier advances most of the value of a specific unpaid B2B invoice and is repaid when the buyer pays. It is tied to individual transactions, the invoices themselves are the main security, and the funding grows as your credit sales grow. It suits firms selling on credit to dependable buyers. The mechanics and costs are covered in invoice discounting explained.

Short-tenure business loan

A short business loan, typically for about a year, is a lump sum repaid in monthly instalments. It is often unsecured and assessed on bank statements, GST returns and credit history, so it can be arranged faster than a bank limit. Because it is usually unsecured it costs more than secured credit, and the instalments start at once. It suits a defined, short need with a visible payback: a bulk purchase ahead of the season, a deposit for a tender, urgent repairs.

Side by side

On flexibility, the revolving facilities lead: cash credit, overdraft and discounting can be used, repaid and reused. Term and short business loans are fixed once drawn, which makes them simpler to plan around but unforgiving if cash flow dips.

Match the money to the life of the need

The governing rule is simple: the tenure of the borrowing should match the life of what it funds. Stock that turns over in two months should be funded by credit that revolves. A machine that will earn for seven years should be funded by a loan repaid over several years. To know how much revolving credit you need, first calculate your working capital cycle.

Common mistakes

• Buying long-term assets from short-term limits. Paying for a machine out of cash credit leaves too little limit for stock, and the account stays at the ceiling all year.
• Funding permanent working capital with a short loan. The instalments pull out cash that the business needs to stay in the cycle.
• Stacking loans. Taking a second and third short loan to service the first raises obligations faster than income, and every lender can see it on the credit report.
• Comparing only the headline rate. Fees, margins and unused-limit charges change the real cost.
• Ignoring the conditions. Stock statements, insurance, renewal and other conditions come with the money; breaching them invites penal charges.

Vaanij Capital is a marketplace rather than a lender. It offers three products from regulated banks and NBFCs — invoice discounting, working capital finance and a 12-month business loan — and you choose among the offers you receive.

This article is general information for business owners. It is not financial advice — loan terms are set by the lender, so read the lender’s own documents before you commit.