Every business has a gap between paying for raw material, salaries and rent, and getting paid by customers. Working capital loans fill that gap. For most Indian MSMEs, this means a cash credit (CC) or overdraft (OD) limit from a bank or NBFC — a revolving line you draw from and repay as cash moves through the business. Choosing the right structure, and managing it well, can save real money in interest and avoid trouble at renewal time.
Working capital loans: cash credit vs overdraft vs term loan
| Cash credit (CC) | Overdraft (OD) | Term loan | |
|---|---|---|---|
| Purpose | Day-to-day working capital | Short-term or flexible needs | Fixed, one-time needs (machinery, expansion) |
| Security | Stock and receivables (hypothecated), often plus collateral | Property, FD or other collateral; sometimes unsecured | The asset financed, often plus collateral |
| How you draw | Any time, up to drawing power | Any time, up to the sanctioned limit | Full amount disbursed upfront or in stages |
| Interest | Only on amount used | Only on amount used | On full outstanding balance |
| Repayment | Revolving; renewed yearly | Revolving; reviewed periodically | Fixed EMIs over the tenure |
Cash credit is the classic working capital loan for traders and manufacturers. The limit is linked to the value of your stock and debtors.
Overdraft is usually sanctioned against a fixed asset such as property or a fixed deposit, so it is not tied to monthly stock levels. It suits service businesses and professionals who do not carry much inventory.
Term loans are better for long-term assets. Using a CC limit to buy machinery locks up working capital you will need for operations — our guide to machinery and equipment finance covers that side.
Drawing power: how much you can actually use
With cash credit, the sanctioned limit is the maximum the bank has approved. But what you can use in any month is your drawing power (DP), calculated from your latest stock statement.
Lenders keep a margin — a portion of stock and debtors they do not finance — and usually exclude creditors (stock you have not yet paid for) and old debtors (often those over 90 days).
A worked example
| Item | Amount |
|---|---|
| Stock | ₹30 lakh |
| Add: debtors under 90 days | ₹25 lakh |
| Less: trade creditors | ₹10 lakh |
| Net current assets | ₹45 lakh |
| Less: margin at 25% (illustrative) | ₹11.25 lakh |
| Drawing power | ₹33.75 lakh |
If the sanctioned CC limit is ₹40 lakh, this business can use only ₹33.75 lakh this month. As stock and debtors grow, DP rises up to the sanctioned limit. Margins and eligible debtor ages vary by lender.
Your drawing power, not your sanctioned limit, decides what you can actually use. Late or understated stock statements quietly shrink your working capital.
Stock statements and monitoring
Banks ask for a monthly or quarterly stock statement listing inventory, debtors and creditors. For larger limits, they may also conduct stock audits and match figures with your GST returns and financial statements.
Good practice:
- Submit statements on time. A delay can freeze or reduce DP.
- Keep figures consistent across stock statements, GST returns and audited accounts. Big mismatches raise questions at renewal.
- Insure the stock with the bank's interest noted, as most sanctions require.
Interest is charged only on what you use
One big advantage of CC and OD limits is that interest is charged on the daily utilised balance, not the full limit.
For instance, if you use ₹20 lakh for 30 days at an illustrative 11% a year, the interest is roughly ₹20,00,000 × 11% × 30 ÷ 365 ≈ ₹18,082. If you bring the balance down when customer payments arrive, interest drops immediately. Some lenders charge a small fee on unused limits or a commitment charge, so check your sanction letter.
Renewal and keeping the account healthy
Working capital limits are usually sanctioned for 12 months and then renewed after a review of your latest financials, stock statements and account conduct. Lenders look closely at:
- Turnover through the account. Routing sales receipts through the CC account shows the limit is genuinely used for business.
- Overdrawals. Staying above DP or the limit for long is a red flag. Continuous overdue beyond set periods can lead to the account being classified as irregular or a non-performing asset.
- Interest servicing. Interest is debited monthly and should be paid promptly.
- Updated documents. Provisional or audited financials, ITRs and GST returns.
Bill and invoice discounting, and TReDS
If your money is stuck mainly in receivables from reliable buyers, invoice-based finance can be a useful addition to a CC limit.
Bill or invoice discounting: you get an advance against an unpaid invoice, minus a discount (the financing cost). When the buyer pays, the lender is repaid.
TReDS (Trade Receivables Discounting System): RBI-authorised online platforms where MSMEs upload invoices raised on larger buyers — corporates, PSUs and government departments. Once the buyer accepts the invoice, banks and NBFCs bid to finance it, and the MSME often receives payment within days. Because the risk is largely on the large buyer, discount rates can be competitive, and many such financings are without recourse to the MSME. You register on a platform and your buyer must be registered too.
Tips for MSMEs
- Size the limit realistically. Too small, and you run short at peak season; too large, and you may pay commitment charges and face tighter scrutiny.
- Separate needs. Use CC/OD for working capital and term loans for fixed assets.
- Chase receivables. Faster collections reduce borrowing and interest more than any rate negotiation.
- Keep a buffer. Do not run the limit at 100% all the time; leave room for surprises. Our guide on building an emergency fund applies to businesses too.
Frequently asked questions
Is an overdraft cheaper than cash credit?
It depends on the security and lender. Overdrafts against FDs or property are often priced competitively, while CC limits depend heavily on your financials. Compare the full cost, including fees.
Can a new business get a cash credit limit?
It is harder, as lenders usually want at least one to two years of financials. New businesses may start with a smaller limit, collateral-backed OD, or a guarantee-backed facility.
What happens if I cannot renew on time?
The limit may be marked overdue for review and the lender may restrict drawings. Submit renewal documents well before the due date.
Key takeaways
- Working capital loans like CC and OD charge interest only on the amount used.
- Drawing power, based on stock and debtors minus margin, limits what you can use under cash credit.
- Timely stock statements and clean account conduct make renewals smoother.
- Invoice discounting and TReDS can free up cash tied up in receivables.
Our team compares working capital structures across multiple banks and NBFCs and helps prepare the documentation. See our loan options to get started. Loan approval, rates and terms are at the sole discretion of the lender.
