What is cash credit account?

Answer 1

There are many ways in which finance can be raised Cash Credit is one of the many ways of raising finance (i.e. it is a type of loan account).

Meaning : Cash credit is an arrangement under which a customer of a bank or financial institution is allowed an advance up to certain limit against credit granted by bank. That means a loan may be granted say for Rs. 1 Lakh however the customer/borrower of the loan may take the amount of loan to the extent required by him but not exceeding the limit of Rs. 1 Lakhs.

Purpose : The purpose for which loan is required is essential to ascertain, as for different purposes different types of loan can be taken. Eg. Incase the loan is required to purchase fixed assets like plant and machinery, term loan must be taken as plant and machinery are long term assets it will take time in repayment of the loan and repayment can be done in EMI's (Equated Monthly Installments). Where as a loan required for working capital needs a long term loan is not required as repayment does not require long period, hence cash credit may be availed.

Explanation of Cash Credit loan facility : If for eg. a person is having a business. To carry on this business he needs to purchase raw material, and sell the goods. For this he needs working capital to run his daily business. Working capital means current assets minus current liabilities. Where current assets comprise of investment in stock, sundry debtors, cash, etc., current liabilities comprise of sundry creditors, suppliers of stock(incase of stock taken on credit), etc. The reason working capital is current asset minus current liabilities because money is required to purchase stock, this stock when still not sold will be of some value for which cash is invested in it and the part that is sold but on credit to customers(debtors) here also cash is not received and cash is invested. Hence in both the items money is put in. On the other hand incase of stock which is purchased on credit (creditors) here no money is put in, i.e. the stock purchased without investment. Hence total amount of money put in or invested in running the business is only to the extent of money invested in stock in hand(for which money is paid) and debtors(where again money is invested) less the amount of stock received on credit form creditors(here the amount is not invested for purchase of stock).
This working capital that is required to run the business can be either funded by the businessman him self or if he does not have the money he can take a loan i.e. Cash credit.
In Cash Credit facility an amount of loan is given to the borrower/businessman for his working capital needs. The entire amount of working capital required is not funded by the bank, some small amount will have to be funded by the businessman and the balance amount will be funded by a bank as a loan. This is as per RBI rules. The amount of loan to be given is decided on the basis of different types of methods like MPBF (Maximum Permissible Bank Finance) suggested by Tandoon Committee or other methods. These methods use formulae which take into consideration actual working capital required.
The amount so worked out is given as loan and is called as "limit" this is because under this kind of loan the borrower may not take up the entire amount of loan as working capital requirement every day is not the same, i.e. on one day the amount of working capital required may for eg. may be Rs. 96,000 and on a another day it may be Rs. 92,000 as some debtor might have paid up some amount. Hence the businessman will require Rs.96,000 on one day and he will require Rs. 92,000 on the other day only. He on a particular day may require Rs. 1,07,300 but the loan amount that he can get is any amount which is not more than the "limit" of the loan given. If in the above eg. Limit is say Rs. 1 lakh then when he requires Rs. 1.07300 he will get loan upto Rs. 1 lakh only.
The reason why he should borrow different amounts on different days as per the amount required by him on that day is that the interest calculated is on daily basis on the amount borrowed by him on different days. i.e. if amount required by him say on a particular day is say Rs.92,000 but he takes entire amount Rs. 1,00,000 he will have to pay interest on entire amount of Rs. 1 lakh. However if he would have only taken say Rs. 92,000 which he required he would have to pay interest on Rs. 92,000 only and not on Rs 1,00,000.

Your second question as to by whom the account is maintained? The answer to that is the bank will maintain the account in its own books and will provide the cash credit account holder with a monthly statement of the account.
As for as accounting in the books of account of the borrower the amount of balance reflected in the statement as on the last date of accounting i.e. say 31/03/2007 called as outstanding balance should be taken in the Balance sheet, liabilities side and the interest amount shown in the statement to be taken to Profit and Loss Account, debit side.