Working Capital Finance 2026:
Cash Credit vs. Overdraft Facilities

What is Working Capital Finance?

Working Capital Finance is a type of short-term commercial loan designed to help a business fund its day-to-day operations. Unlike a Term Loan, which is used to buy fixed assets like machinery or a factory building, working capital is used to pay for raw materials, employee salaries, utility bills, and to bridge the gap between selling a product and actually receiving payment from the client.

The core operating cycle of any manufacturing or trading business involves buying inventory, holding it, selling it on credit, and then waiting 30 to 90 days for the buyer to pay the invoice. During this waiting period, cash is trapped. A working capital facility provides a revolving line of credit to keep the business running smoothly without cash flow interruptions.

The two most common forms of working capital finance in India are Cash Credit (CC) and Overdraft (OD).

Cash Credit (CC) vs. Overdraft (OD)

Many business owners use the terms CC and OD interchangeably. However, from a banking and underwriting perspective, they are entirely different products designed for different types of businesses.

1. Cash Credit (CC) Limit

A Cash Credit facility is granted against the hypothecation of current assets. This means the loan limit is directly tied to the value of the physical inventory (raw materials, work-in-progress, finished goods) sitting in your warehouse, plus your book debts (unpaid invoices from customers).

• Best For: Manufacturers, Wholesalers, Distributors, and Retailers who hold physical stock.
• Security: Hypothecation of Stock and Book Debts.
• Maintenance: Requires the submission of a detailed monthly Stock Statement to the bank.

2. Overdraft (OD) Facility

An Overdraft facility is generally granted against fixed collateral, rather than fluctuating business inventory. If you pledge a residential house, commercial office, or a Fixed Deposit (FD) to the bank, they will give you a revolving line of credit against that asset's value.

• Best For: Service sector businesses, IT agencies, contractors, or professionals who do not hold physical inventory.
• Security: Mortgage of immovable property or assignment of liquid assets (FDs, Mutual Funds).
• Maintenance: Usually does not require monthly stock statements, making it operationally easier to manage.

The Critical Concept of Drawing Power (DP)

This is the most misunderstood concept in commercial banking. If a bank sanctions you a ₹5 Crore Cash Credit limit, it does not mean you can withdraw ₹5 Crores at any time. Your actual withdrawal limit fluctuates every month based on your Drawing Power (DP).

Your Drawing Power is calculated directly from the monthly Stock Statement you submit to the bank. The bank applies a safety "margin" (usually 25% for stock and 40% for debtors) to make certain they are not funding 100% of your assets.

In this scenario, even if the business has a sanctioned limit of ₹2 Crores, their actual Drawing Power for that specific month is capped at ₹85 Lakhs. If they try to write a cheque for ₹90 Lakhs, the cheque will bounce, and the account will go into overdrawing status, triggering penal interest.

How Banks Calculate MPBF

When you apply for a new Cash Credit limit, how does the credit manager decide if you deserve ₹1 Crore or ₹5 Crores? They use a strict formula called Maximum Permissible Bank Finance (MPBF).

Most PSU banks utilize the Tandon Committee Method II to evaluate MPBF. Under this method, the bank requires the business owner to bring in at least 25% of the total current assets as their own contribution (Net Working Capital).

To secure a larger limit, you must convincingly project a higher turnover, which mathematically increases your required current assets. However, if your projected turnover is drastically higher than your historical audited financials, the credit manager will reject the projections as unrealistic.

Collateral & CGTMSE Backing

Working capital loans can be structured in two ways regarding collateral:

1. Collateral-Backed Limits

This is the traditional route. The bank requires you to pledge residential, commercial, or industrial property. Typically, the bank expects a collateral cover of 100% to 125% of the sanctioned limit. If you want a ₹2 Crore limit, you must pledge property worth at least ₹2 Crores.

2. CGTMSE Covered Limits (Zero Collateral)

As discussed in our previous guides, the government offers the CGTMSE trust cover for MSMEs. If your manufacturing or trading business has an active Udyam Registration, you can secure Cash Credit limits up to ₹5 Crores without pledging any physical property. The government guarantees the loan for an annual fee (AGF). However, the bank's scrutiny of your financial health, CIBIL score, and MPBF projections will be significantly more rigorous.

Real World Case Studies

Let us review how a trading firm manages its working capital cycle utilizing a Cash Credit limit.

Common Rejection Reasons

Working capital loans are continuously monitored. Here is why applications fail or existing limits get frozen:

• Stale Debtors: Banks typically do not accept unpaid invoices older than 90 days in the DP calculation. If your business is failing to collect payments for 6 months, the bank will classify those debts as "bad" and strip them from your Drawing Power.
• Poor Inventory Velocity: If the bank inspects your warehouse and finds obsolete, unsold stock gathering dust, they will not count it toward your limit. They want fast-moving current assets.
• Negative Net Working Capital: If your current liabilities (money you owe) exceed your current assets (what you own), you are operating with negative working capital. The bank will reject the limit increase immediately.