Both let you draw below zero and pay interest only on what you use. The difference is what secures the limit, and that changes who can get one.
Term loans are for buying things. Revolving facilities are for covering the gap between paying out and being paid. For most businesses, that gap is the more frequent problem.
Two products dominate here, and owners often use the names as if they meant the same thing. They do not, and the difference decides which one you can actually get. This guide explains how each works, what the lender checks, and how to tell which fits your business. For the product itself and how to request it, see cash credit and overdraft.
The shared mechanic
Both give you a sanctioned limit you can draw against as needed. (A sanction is the lender's formal approval of the amount and terms.) You pay interest only on what you actually use, for the days you use it. Repay, and the limit is available again.
That is the key advantage over a term loan. If you need funds for eleven days a month, you pay interest for eleven days. You do not pay a fixed EMI every month for three years.
Both are usually reviewed and renewed each year. Renewal is when the lender looks hardest at how you used the limit.
Cash credit
Cash credit is secured against your current assets, mainly stock and money owed to you by customers (receivables).
How the limit is set. For micro and small enterprises with working capital limits up to ₹5,00,00,000, the government has described a simplified method: the limit is computed as at least 20% of projected annual turnover. Larger limits are usually assessed from your full working capital cycle.
How much you may draw. Within the limit, what you can actually draw at any time is your drawing power. Banks work it out from a current stock statement. A common formula is eligible stock plus eligible receivables, minus what you owe suppliers, less a margin, capped at the sanctioned limit. The exact formula is each bank's practice.
The reporting that surprises owners. RBI's asset classification rules say drawing power must be based on a current stock statement. Statements relied on should not be older than three months, or the drawings are treated as irregular. So cash credit needs a routine of periodic stock and receivables statements, and the drawing power moves with them. A quarter of thin stock can reduce what you may draw, sometimes just when you feel you need it most.
Because the security is your trading assets, cash credit suits businesses that carry real stock or give customers credit. Manufacturing, distribution, wholesale and larger retail fit naturally.
Overdraft
An overdraft is sanctioned against your account and your overall creditworthiness, or against other security such as property or a fixed deposit, rather than against trading assets specifically.
That makes it reachable for businesses that carry little stock: services, consultancies, professional practices and agencies. It often involves lighter ongoing reporting, because there is no stock statement driving the limit.
Where an overdraft is secured against property, the terms usually improve. Everything about property-backed lending then applies, including the risk to the property.
How government schemes use the two
Government schemes show how lenders think about the split.
- The Stand-Up India guidelines (the scheme ran to 31-Mar-2025) allowed working capital up to ₹10,00,000 as an overdraft, with a RuPay debit card for convenience. Above ₹10,00,000, it was sanctioned as a cash credit limit.
- The Mudra Card is a RuPay debit card that gives a Mudra borrower a working capital line in the form of cash credit or overdraft. It can be used at ATMs and shops, and repaid when the business has surplus cash.
The pattern is the same: smaller, simpler needs suit an overdraft; larger limits tied to trade suit cash credit.
Collateral on small limits
For loans to micro and small enterprises sanctioned or renewed on or after 01-Apr-2026, banks may not take collateral security on loans up to ₹20,00,000. That includes working capital. A bank may stretch this to ₹25,00,000 for a unit with a good track record. Above that, the CGTMSE guarantee for micro and small enterprises can cover term loans or working capital given without collateral. You still have to qualify; the rule only changes what security can be asked for.
Choosing between them
Cash credit fits a business whose money is genuinely tied up in stock and debtors. The limit scales with the trading cycle, and the stock reporting is a manageable routine rather than a burden.
An overdraft fits a business without much stock, one that wants a simpler facility with less paperwork, or one that can offer other security.
For many smaller businesses the practical answer is whichever the lender offers, since eligibility rather than preference decides it. A business line of credit from an NBFC (a non-banking financial company regulated by RBI) is a third option some businesses use. Before you choose, sizing the need with a cash flow forecast and the working capital calculator tells you how big a limit to ask for.
What each one costs
The rate is only part of the price of a revolving limit. Before you accept either, ask four questions and write the answers down in rupees:
- What is the processing fee at sanction, and is there a fee at each annual renewal?
- Is there a charge on the part of the limit you do not use? Some lenders apply one.
- What are the stock audit, inspection or valuation charges, if any?
- What penal charge applies if you draw above your drawing power?
A limit with a slightly higher rate but no renewal or unused-limit charges can cost less over a year, if your usage is light. The true cost of a business loan shows how to compare offers line by line.
Where both go wrong
A revolving facility is designed to be used and cleared repeatedly. The warning sign is a limit that never comes back down.
If your balance sits near the ceiling month after month, the facility has stopped being working capital. It has become a permanent loan at a working capital rate. That usually means one of two things. The business is short of long-term capital, or it is absorbing a loss it has not yet acknowledged.
There is a hard line too. Under RBI's asset classification rules, an account whose drawings stay irregular for 90 days in a row can be classified as a non-performing asset (NPA). Drawing above your drawing power, or running on a stock statement that has gone stale, counts. An NPA classification makes later borrowing much harder.
Lenders watch for these patterns at renewal. A permanently drawn limit is a common reason a facility is cut rather than renewed. That is a hard moment for a business already relying on it.
Penalties for breaking the terms are also regulated. Since 01-Jan-2024, a penalty must be a penal charge, not penal interest added to your rate, and no interest may be charged on it. Check the amount in your sanction letter anyway.
The practical test
Look at your account over the last year. How often did the balance come back well below the limit?
If the answer is regularly, a revolving facility is the right tool and you are using it correctly. If the answer is rarely or never, more limit is not the fix. The gap is structural. The honest response is a properly sized term facility with a repayment plan, not a larger overdraft to fall further into. Working capital versus a term loan explains how to tell the two needs apart, and what your bank statements tell a lender shows how lenders read the same account.
Capnix is not a lender. Its free Capnix score rates your business from 0 to 100 and shows what to fix before you take a working capital requirement to a lender. For the wider range of options, see working capital loans.
Sources
- PIB, government reply on simplified working capital for MSE units (23-Jul-2019), checked 02-Oct-2026
- RBI, Master Circular on prudential norms on income recognition, asset classification and provisioning (01-Jul-2011), checked 02-Oct-2026; the drawing-power formula is bank practice
- Stand-Up India, scheme details and Department of Financial Services, Stand-Up India, checked 02-Oct-2026
- MUDRA, FAQs, checked 02-Oct-2026
- RBI, collateral-free loans to MSE units (RBI/2025-26/206), checked 02-Oct-2026
- CGTMSE, Credit Guarantee Scheme document (updated 01-Apr-2026) and cgtmse.in, checked 02-Oct-2026
- RBI, Fair lending practice: penal charges in loan accounts (RBI/2023-24/53), checked 02-Oct-2026
