Cash Credit
Cash Credit is defined as a source of short term finance for companies. They are also known as working capital loans because they aim to fund the immediate cash requirements of the organization or to purchase current assets. The borrowing limits for the amount of cash present for credit for the company is different for each commercial bank. The interest is charged on the closing balance at the end of a day and not the upper borrowing limit. This is why the repayment is made only on the total amount that is spent out of the available limit. Since it is only taken for a short term duration, the repayment for the amount that is taken on credit needs to be completed within twelve months.
Cash credit is basically a loan, and the banks will demand some collateral or security to approve it. This facility is very similar to the overdraft option provided by banks in many ways, although there are major differences between the two. Cash credit is provided to the company for a shorter period of time when compared to overdrafts, and the interest rate is also lower for this option. The cash credit option is available to businesses as well as financial institutions, who also have to provide collateral to the bank. It is generally approved by the bank based on the creditworthiness of the borrower and the relationship between the two parties.
Trade Credit
Trade credit is defined as a business-to-business agreement between the customer and supplier. The main idea of this facility is to allow a customer to purchase goods with the option of paying the supplier for the goods at a later date that is scheduled beforehand. The duration for trade credit provided by the suppliers is mostly around 30, 60 or 90 days, and the entire transaction is recorded through an invoice. This option of trade credit is akin to zero per cent financing for the borrower company as it helps them to increase their assets while at the same time paying for the goods or services at a specified date in the future. The trade credit facility depends on the relationship between the borrowing and the lending party. If the borrower shares a good understanding with the supplier, they may be able to negotiate a longer repayment time which will definitely work to their advantage.
Many sellers will have specific terms and conditions that they will follow while providing trade credit to their customers. It helps them secure their money as well as ensure repayment in most, if not all, cases. The main advantage of trade credit is that it can help businesses to manufacture and sell goods and generate a revenue stream without paying for those goods immediately.
Difference between Cash Credit and Trade Credit
There are several points of difference between cash credit and trade credit. We will explore some of them below:
Cash credit is short term finance provided by banks to companies. | Trade Credit is an agreement between the supplier and customer to purchase goods on credit. |
Cash credit is provided by banks to their customers in exchange for collateral or security. | Trade credit is provided by suppliers to their customers without any exchange of collateral or security. |
The banks provide cash credit to businesses for a minimum duration of one year. The duration depends on the amount and purpose of the loan. | The supplier provides trade credit to their customers for a much shorter time period of 30, 60 or 90 days. The duration, however, can be extended based on the relationship between the two parties. |
The interest rates for the cash credit facility are decided by the bank. It is based on the loan amount and purpose. | The interest rate for trade credit is decided by the supplier. It is based on the amount of credit extended to the customer and the relationship between the two parties. |
A company or business needs to open a bank account to get a cash credit facility. | There is no requirement of having a bank account to get the trade credit facility. |
Cash credit is offered to companies solely based on the performance of their business and the prevailing market situation. | Trade Credit is offered to customers based on their relationship with the supplier and creditworthiness. |
Conclusion
Although there is a difference between cash credit and trade credit, both are extremely important to running a business. Companies have the freedom to prefer one over the other based on their business needs and interest rates. Both these credit instruments play a huge role not just in the running of individual businesses but also in the development of a nation’s economy.
Frequently Asked Questions
Q1
What are some of the situations in which a company can look for Cash Credit?
A company can look to avail the cash credit facility to meet their working capital gap in the following situations:
- Payment of salaries and rent to workers
- Maintaining inventory
- Purchasing raw materials
- Financing the company sales
- Storage and warehousing needs
Q2
Why are suppliers at a position of disadvantage when it comes to trade credit?
The suppliers are at a disadvantage vis-a-vis trade credit because they have sold the goods to the customer, but they will get paid only after a predetermined period of time. Another disadvantage for the supplier is that there is a chance that the customer may not pay the supplier on time or even default on the payment.
Also See:
- Meaning of Economic and Non-Economic Activities
- Advantages of SLM and WDV for Calculating Depreciation
- Difference between Depreciation Expense and Accumulated Depreciation
- Difference between Monopoly and Monopolistic Competition
