Cash Credit Meaning
Cash credit is one of the methods of financing provided by the banks and financial institutions to their business customers by taking the customers’ collateral in exchange for cash. It is not often offered to individual customers.
The cash credit limit is based on the borrower’s need and their payment capacity as agreed with the bank which is similar to other bank’s facilities. Banks calculate the net trading assets of the company and finance 70% of the net trading assets.
What are the collaterals to apply for cash credit?
How to calculation cash credit limit?
As mentioned above, the bank or financial institution will provide the cash credit to their customers for certain percentages of the total value of the collateral.
Here is how to calculate the cash credit limit,
|Value of stock||XXX|
|Value of debtors||XXX|
|(-) Value of creditors||XXX|
|Net trading assets||XXX|
|Cash credit limit (Borrowing power)||70% of net trading assets|
The limits for such cash credits are sanctioned and interest is charged on the loan amount actually used by the borrower. The security of cash credit is arranged by means of hypothecation of stock, pledge.
The features of cash credit are as follows:
- This loan is meant to meet the working capital requirements of the company. It is generally given for one year or a period less than a year.
- It is given against collateral security. The banks employ that the market value of the security should be 120% or more than the value of the loan.
- Interest is charged on the amount of loan used and not on the limit sanctioned.
The advantages of cash credit are as follows:
- It is useful short-term source of financing.
- Interest is charged on the utilized amount only.
- It can be sanctioned easily and quickly and is hassle free.
The disadvantages of cash credit are given below:
- Delay in payment of cash credit disturbs their credit planning and credit score of the banks.
- Such loans are given on the basis of ratio analysis of its financial statements and audit report hence it becomes difficult for small firms to obtain the loan.
- The cash credit system makes difficult for bank to have any control over the end use of the loan amount.
- The cash credit system leaves enough room for the borrowers to take loans from multiple banks which might result in banks getting cheated.
- It is renewed from year to year unless cancelled and the loan with interest due amount being paid in final settlement. Every year, renewal procedure shall be followed and almost all procedures are followed as if new loan is sanctioned.
Process of cash credit loan:
- Application for the loan: The application is filled by the eligible borrower with his personal details, loan amount, photo and identity documents.
- The loan proposal is prepared by the bank staff. He gathers information about the collateral of the land i.e., land or building. He verifies the ownership of the collateral through the land ownership document or property registration certificate.
- Calculation of the EMI of the loan and assessment of the paying capacity of the borrower. The staff estimates yearly income of the borrower by compiling his income details against the salary slips, agricultural income verified by the local government, rental income and deductions of his yearly expenses including the safety margin of 10% (assume). His net income is finally arrived at.
- The ratio of net income and EMI of loan is calculated. If the net income is twice or more than the EMI of the loan, the loan can be granted among other factors such as location and valuation of land. The land must be in the name of borrower or any immediate family member.
- If the above conditions are met, the loan can be granted. One or more guarantors are required to sign in the guarantee agreement that if the borrower fails to pay the loan, the guarantor would be liable to pay.
- The guarantor agreement is prepared wherein his identity document number, parent’s name, and borrower’s name are mentioned and the guarantor agrees to pay the bank in case of failure of payment by the borrower. It is mentioned in the agreement that banks can realize the loan amount by the auction of the collateral or seizure of the bank accounts with other banks.
- The hypothecation agreement is prepared wherein the description of the valuation and content of stock is mentioned with the loan amount and it is duly signed by the borrower with the two witnesses.
- An internal loan deed is prepared as an agreement between the bank and the borrowing party. The internal loan deed entails the loan amount, address and identity of the borrower, details of the owner, measurement, and location of land kept as collateral. The deed is signed by the borrower, the witnesses, and the bank.
- The recovery from the receivable’s agreement is prepared to assign the receivables of the company in the name of the bank in case the borrower fails to pay the amount in time. The bank can realize from the debtors of the borrower if the borrower defaults in payment.
How does cash credit work?
Cash credit is normally offered to a company that is short of cash to support its operation. And to get the cash credit the company needs to apply to the bank or financial institution that offers such a facility. Normally, the bank will need the customers to have the collateral to secure the cash credit.
The bank will also need to assess the others factors other than the collateral to ensure that the customer could pay back the com cash that it uses to withdraw.
The bank normally offers cash credit for a certain amount of the collateral of the company. For example, up to 80% of the collateral.
This kind of facility is kind of short-term and the interest rate is normally higher than the loan, but it is depending on the bank. Interest is only when the cash credit is withdrawn by the customers.
What’s a Credit Card Cash Advance?
After the bank approves the cash credit, the customers could normally have the cash credit card that will issue by the bank. This cash credit card could be used to advance the cash from the bank up to the limit amount that the bank approves.
However, it is depending on the bank. Some bank offers a credit card to easily advance or withdraw cash. And some bank does not.