Understanding Cash Credit, Overdraft (OD) and Dropline OD

Many of the businessmen turn towards Banks to meet their funding needs for working capital requirements. However, they get confused as to what type of working capital instrument would suit them given their personal and professional objectives. The objective of this article is to decipher this confusion and give clarity on the subject matter.

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Types of Fund Based Working Capital

Following are the three most common types of working capital funding instruments, which a business borrower can resort to from Banks

1. Cash Credit (CC):

In this case, the Bank sanctions a particular amount of credit limit and you are free to use any amount within that limit. Interest is levied only on the amount you actually utilise (on daily balance basis) and not on the full sanction limit. However, the maximum amount you can use in a particular month is lower of the two parameters:

a. actual sanction limit or

b. amount derived as per your eligibility in the Drawing Power (DP) statement.

2. Bank Overdraft (OD):

Bank Overdraft is generally given to very small borrowers and works similar to Cash Credit on the same principle. However, one major difference is that the requirement of DP statement is not applicable here and one need not submit any stock statement related information to the Bank on a monthly basis. Here also, you pay interest on the amount actually utilised on a daily basis.

3. Dropline Overdraft (DOD):

Dropline Overdraft (DOD) is an innovative concept and is introduced by certain banks to cater to the working capital needs of certain sections of the borrower. At times, the borrower wishes to get debt free but knows that this cannot happen overnight - it has to be a gradual and disciplined process. Dropline Overdraft (DOD) comes to the rescue for these types of borrowers. In case of Dropline Overdraft (DOD), one is free to utilise the working capital funds just like CC / OD and you actually pay interest only on the amount utilised. However, every month, a fixed amount of credit limit is gradually reduced so as to ensure that you have discipline to manage your business with a little lower banking limits. Over a period of next 3-5 years, it is expected that your limit gradually becomes zero; you have a good discipline to run your business without bank funding and become debt free.

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Difference Between the Different Types of Fund Based Working Capital

A tabular comparison of all the there working capital instruments is given hereunder:

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4 Columns and 15 Rows Table

Parameters	Cash Credit	Overdraft	Dropline OD
Credit Limit	Fixed	Fixed	Reduces gradually
Purpose	For working capital	Could be for general business purpose	Normally for working capital
Credit Limit	Fixed	Fixed	Reduces gradually
Interest	Charged at month end on running daily balances
Interest Rate	Slightly lower than other instruments	Marginally higher than Cash Credit (at times)
Processing Fee	Applicable & paid on entire sanction limit		Paid on entire limit even though you don’t have that limit for full year
WCDL sub-limit	Can be given on case to case basis	Not offered
Drawing Power (DP) Statement	To be submitted every month	Not needed	Normally not required
Stock Audit	Required to be done (at borrower’s expense)	Not Required
Collateral Needed	Marginally lower than Overdraft / Dropline OD	Marginally higher than Cash Credit
Repayment of Loan	Ideally, on bank’s demand; however, the same gets annually renewed and no repayment actually happens On Demand		Monthly, quarterly,half yearly or yearly
Tenure	12 months	12 months	For longer period
Monitoring by Bank	Regularly	Irregular	Partially Done
Bank’s Comfort	Very likely - most common product, subject to credit satisfaction	For small loans and depending upon the nature / profile of the borrowers	Mixed (only certain banks)

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Which banking instrument (CC / OD / DOD) is good for you?

Deciding between the cash Credit, Bank Overdraft and Dropline OD can be a mounting task. The answer to above depends upon a host of factors.

Overdraft facility is generally offered by Banks only on loans upto Rs. 3-5 crore. For amounts beyond Rs. 5 crore, banks prefer to seriously monitor the borrower’s financial performance rigorously and review stock statements every month. Hence, they shall offer Cash Credit and not Overdraft facility.
What is your mindset and capability as a borrower? Do you want to become debt free? Then, a forced discipline mechanism of Dropline OD would be apt for you. However, in case you think the business will severely get impacted because of consistent limit reduction every month and you shall not be at ease; then Dropline Overdraft (DOD) is not meant for you.
Do you have enough resources / bandwidth / systems within your company, who shall work tirelessly and provide the DP Statement to the Bank every month? If no, then you may explore availing Overdraft instead of CC or simply choose to contact us at BankKeeping.

So, to conclude, all these instruments, Cash Credit, Overdraft and Dropline OD, have their own pros and cons and these have been designed by Banks keeping in mind the different categories of borrowers. So, go ahead and choose the one which is best suited for you.