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CASH CREDIT

Learning Objectives:

To understand the meaning of a


Cash Credit
To understand how a Cash Credit
limit is fixed

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CASH CREDIT

4.1 Introduction
Cash Credit is a facility given by banks to finance
working capital.
A person/company needs money to make / buy
goods to sell. If the company sells goods on
credit, it would take time to receive the money
for the goods sold. The person/company would
therefore need finance for debtors also.
The finance given to purchase
goods/manufacture goods and finance debtors
is known as cash credit.
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4.2 CASH CREDIT FIXATION:
A Banker fixes cash credit limit after taking into
account several features of the borrowing
concern such as production, sales, inventory,
past utilization of such limits etc.
The cash credit limit is based on the
inventory/stock for up to a certain number of
months and debtors outstanding upto a certain
number of months.
The limits are sanctioned on a year to year basis
and are periodically reviewed.
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e.g. If time taken by a company to
manufacture an item is 90 days and then to
sell it takes another one month. Goods are
sold on credit for 60 days. Thus the cycle from
beginning to payment is 150 days. The limit
will be calculated on stocks for 90 days and
debtors for 60 days.

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Drawing power :
After fixing a limit, the bank would advice the
customer how much he may draw at a point in
time. This is usually 60% to 70% of current
stock ( slow moving and obsolete stock being
excluded) and 60% to 70% of debtors upto
180 days who are considered good.

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e.g of Drawing Power calculation
Let us assume the bank agrees to finance 3
months stock and 2 months debtors. Sales are
Rs.12 lakhs annually and the mark up is 20%.
Therefore the value of goods sold would be Rs.10
lakhs. Three months stock ( purchase price would
be Rs.2,50,000. With regard to debtors, 2 months
sales would be Rs.2 lakhs. The total requirement
would be Rs.4,50,000. The bank may agree to
finance 60% of stock and 80% of debtors.

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CASH CREDIT SANCTIONED WOULD BE :
Stock 60% of Rs.2,50,000 = Rs. 1,50,000
Debtors 80% of Rs. 2,00,000 = Rs. 1,60,000
Total cash credit sanction = Rs. 3,10,000
The person / company would be expected to
finance Rs. 1,40,000

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CASH CREDIT
4.3 INTEREST
Interest is charged on the actual amount
utilized by the customer i.e the balance at
the end of the day.
Interest is charged monthly.

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CASH CREDIT
4.4 OPERATION

Cash credit is just like a current account with


the only addition that the party is sanctioned
a limit upto which he may draw cheques over
and above his own credit balance, if any.
There are no restrictions as to the number of
transactions.

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CASH CREDIT
4.5 HYPOTHECATION
As cash credit is financed against stocks and
debtors, these are usually hypothecated to the
bank. In case of default by the borrower, the
bank can seize the assets hypothecated and
sell them to third parties to realize the
amounts due.
The margin not financed is called owners
equity.

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CASH CREDIT
4.6 COMMITMENT CHARGE
To neutralize the loss of interest on the funds
unutilized, a commitment charge is levied on the
unutilized limits.
Commitment charge exists for two purposes:
(a)To encourage proper management of funds by banks
(b)Bring about better discipline in availing of finance by
borrowers.
This requirement to levy a commitment charge on utilized
portion was withdrawn by RBI, but banks are advised to
evolve their own guidelines to ensure credit discipline.

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4.7 ADVANTAGES OF CASH CREDIT ACCOUNTS
(1)Flexibility and convenience
(2)Borrowers can recycle their funds efficiently
and minimize interest charges by depositing all
cash accruals in the bank account and thus keep
the drawals at the minimum.
(3)Lessor cost of funds to borrowers and better
turnover of funds to Banks.
(4)As banks maintain only one account for all
the transactions of the customer, repetitive
documentation is avoided
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4.8 DISADVANTAGES
(1)Since limit is fixed once a year, it gives rise to the
practice of fixing larger limits than is required for most
part of the year.
(2) Borrowers misutilize the excess available times of
credit restraint.
(3) If the needs escalate due to increased
debtors/stocks due to increased sales, clients
experience difficulty.
(4) It is often difficult to check end use of funds and it is
possible that funds may not be properly utilized.
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In Raneegunj Coal Association and another vs.
Union Bank of India and others, the Supreme
Court has described cash credit in the following
words Cash credit is a drawing account against
credit granted by a bank and is operated in
exactly the same way as a current account on
which an overdraft has been sanctioned. There
can therefore, be no doubt that a cash credit
account is in the nature of a current account and
no interest is payable in this account.

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Next Chapter 5
Overdrafts
Chapter 4 Corporate Banking

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